Firms histories, managerial entrenchment and leverage ratio from vietnams listed firms

UNIVERSITY OF ECONOMICS ERAMUS UNIVERSITY ROTTERDAM HO CHI MINH CITY INSTITUTE OF SOCIAL STUDIES VIETNAM THE NETHERLANDS VIETNAM – NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS FIRMS’ HISTORIES, MANAGERIAL ENTRENCHMENT & LEVERAGE RATIO FROM VIETNAM’S LISTED FIRMS BY PHAM LE PHUONG LAN MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, NOVEMBER 2016 Page | i UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS FIRMS’ HISTORIES, MANAGERIAL ENTRENCHMENT & LEVERAGE RATIO FROM VIETNAM’S LISTED FIRMS A thesis summited in partial fulfillment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By PHAM LE PHUONG LAN Academic Supervisor: Dr VO HONG DUC HO CHI MINH CITY, November 2016 DECLARATION I hereby declare that the content of this dissertation is developed, written and completed by myself The thesis has not been accepted for any degree and institution in my name Additionally, I certify that this work will not, in the future, be submitted in my name for any other diploma and university To my best knowledge and belief, my research has not been contained any previously published material, excepting for all carefully and clearly cited references The thesis has not been finalized without the supervision and guidance of Dr Vo Hong Duc, Economic Regulation Authority, Western Australia and Open University, Ho Chi Minh City Any other support and encouragement has been profoundly acknowledged Ho Chi Minh City, November 2016 Pham Le Phuong Lan Page | ii ACKNOWLEDGEMENT I would first like to express my utmost gratitude for my supervisor, Dr Vo Hong Duc, for his brilliant guidance and his patience, tolerance, caring and understanding In addition, his burning motivation, inspiration, enthusiasm and his excellent insight and expertise, from the first lecture on Day one, have been a profound influence on me in every day He provides me with a valuable opportunity and a great honor to follow his wisdom supervision Without his persistent guidance and assistance, I could not been able to accomplish my thesis and also better myself I would like to send my appreciation to the Vietnam Netherlands Programme, to all lecturers for their teaching method and to the staffs and my friends for their magnificent support Specially, I would like demonstrate my gratitude to Dr Truong Dang Thuy for sharing constructive comments and econometric technique that improve the manuscript From the bottom of my heart, I am indebted to my parents and my brother for the unconditional love, endless support, and unlimited tolerance regardless of how imperfect I am For my whole life, my caring father and my understanding mother are the ones who raise me up whenever I feel sorrow, teach me what is right from wrong and believe in what I choose so that I can pursue my studying Simply, home is home – the place where I belong to Page | iii ABSTRACT Corporate governance principles provide the framework for firms to achieve their objectives The framework is generally considered as the interactions between management, board, and shareholders Fundamental theories and findings from empirical studies primarily indicate that strong corporate governance successfully promotes a business success in relation to both management and finance by reducing agency conflict and achieving an optimal level of capital structure The effect of corporate governance on capital structure has been raised and investigated in various empirical studies for an extended period of time Within the corporate governance framework, the relationship between managerial entrenchment and leverage ratio has attracted great attention from academia, practitioners, and policy makers from developed world However, this important link has not been sufficiently considered and investigated in the context of developing nations, including Vietnam Using a sample of 289 non-financial firms listed on Ho Chi Minh Stock Exchange during the period 2006-2015, this study is conducted to provide two major pieces of empirical evidence to fill the following gaps in current research of corporate governance in the Vietnamese context First, for the first time in Vietnam, the effect of corporate governance, managerial entrenchment, together with the market timing behavior on leverage ratio is considered In this study, managerial entrenchment is proxied by blockholder holdings, board size, director age, CEO-Chairman duality, board composition, and CEO age Also, market timing behavior is represented by firms’ histories on leverage ratio which is measured by the ratio between book leverage and market leverage Second, the impact of managerial entrenchment on firm’s leverage ratio is then classified into two distinct regimes, including a high entrenchment regime and a low entrenchment regime Furthermore, a two-stage approach is used in this study: (i) to determine the target leverage level; and (ii) to quantify the effects of managerial entrenchment and firms’ histories on the observed leverage level of listed firms in Vietnam Variety econometric techniques, along with the traditional Ordinary Least Squares (OLS) method, are incorporated such as the Generalized Method of Moments (GMM) and endogenous switching regression method Key findings achieved from this study can be summarized as follows Page | iv First, empirical evidence indicates that there is a negative relationship between managerial entrenchment and leverage ratio Findings from this study confirm the view that entrenched managers’ decision to reduce a leverage ratio by issuing equity is consistent with market timing behavior Second, the results achieved from the study demonstrate that a negative effect of firms’ histories including financial deficit and various timing measures together with stock price histories on leverage ratio of Vietnam’s listed firms is found over the research period Third, the impact of high managerial entrenchment regime and low managerial entrenchment regime and firms’ histories on book leverage ratio and market leverage ratio is found in this study The results confirm that high-entrenched managers pay attention on the market timing and benefit from the equity market As a result, they reduce a leverage ratio utilized in their firms Fourth, the results present that the high managerial entrenchment regime is in relation to larger number of block-holders, larger boards, older CEOs with CEO-Chairman duality and more outside directors Fifth, findings from this study also reveal empirical evidence to support the view that the change of leverage ratio is a negative response to financial deficit, profitability, timing measures – yearly timing and long-term timing and an alternative timing measure – insider sales, and stock price returns Considerably, the downward adjustment of debt ratio results from the high managerial entrenchment effect Sixth, high authority of entrenched managers to the board could be linked to weak corporate governance in the Vietnamese context This observation is based on the reports of International Finance Corporation and the State Securities Commission Vietnam (2006) and International Finance Corporation and the State Securities Commission Vietnam (2012) Key words: Managerial entrenchment, Firms’ histories, Leverage ratio, GMM, Endogenous switching regression model, HOSE Page | v TABLE OF CONTENTS DECLARATION ii ACKNOWLEDGEMENT iii ABSTRACT iv TABLE OF CONTENTS vi LIST OF TABLES x LIST OF FIGURES xi CHAPTER INTRODUCTION 1.1 Problem statement 1.2 Research objectives 1.3 Research questions 1.4 Research scope 1.5 The thesis structure CHAPTER 2.1 LITERATURE REVIEW Literature review 2.1.1 Corporate governance framework 2.1.1.1 Corporate governance principles 2.1.1.2 Why does corporate governance matter for an organization? 2.1.2 The theoretical framework of corporate governance 2.1.2.1 Agency theory 2.1.2.2 Signaling theory 2.1.3 The capital structure theory 2.1.4 Managerial entrenchment and capital structure decisions theory 11 Page | vi 2.1.5 2.2 Market timing and capital structure theory 12 Empirical evidence 14 2.2.1 The influence of managerial entrenchment and leverage ratio 14 2.2.2 The impact of firms’ histories on leverage ratio 15 2.3 2.2.2.1 Financial deficit and Leverage ratio 15 2.2.2.2 Market timing and Leverage ratio 15 2.2.2.3 Stock price returns and Leverage ratio 26 Hypotheses 17 2.3.1 2.3.1.1 Block-holder holdings and Leverage ratio 17 2.3.1.2 Board size and Leverage ratio 18 2.3.1.3 Director age and Leverage ratio 18 2.3.1.4 CEO-Chairman duality and Leverage ratio 18 2.3.1.5 Board composition and Leverage ratio 19 2.3.1.6 CEO age and Leverage ratio 19 2.3.2 2.4 Managerial entrenchment and Leverage ratio 17 The relationship between firms’ histories and leverage ratio 20 2.3.2.1 Financial deficit and Leverage ratio 20 2.3.2.2 Market timing measures and Leverage ratio 20 2.3.2.3 Stock price returns and Leverage ratio 21 2.3.2.4 Profitability and Leverage ratio 21 2.3.2.5 Leverage deficit and Change in target leverage 22 Analytical framework 23 CHAPTER 3.1 RESEARCH METHODOLOGY AND DATA 24 Vietnam’s corporate governance and securities market framework 24 3.1.1 Vietnam’s corporate governance and institutional background 24 Page | vii 3.1.1.1 Vietnam’s adoption of corporate governance standards 24 3.1.1.2 Vietnam’s corporate governance framework 24 3.1.2 The background of Vietnam’s securities market 26 3.2 Data sources 28 3.3 Research methodology 28 3.3.1 The two-stage approach in determining leverage ratios 28 3.3.1.1 The target leverage ratio estimation 28 3.3.1.2 Model specification 30 3.3.1.3 Measurement of variables 31 3.3.2 The Generalized Method of Moments (GMM) 36 3.3.3 Endogenous switching regression method 39 3.3.3.1 The selection equation 39 3.3.3.2 The structural equations 39 CHAPTER 4.1 THE EMPIRICAL RESULTS 42 Data descriptions 42 4.1.1 Descriptive statistics 42 4.1.2 Correlation 46 4.2 The target leverage estimation 50 4.3 The influence of managerial entrenchment effect and firms’ histories on Vietnam firms’ leverage ratio 51 4.3.1 The choosing of time period (t-n) – lag order selection for the model specification 51 4.3.2 Multicollinearity, autocorrelation and heteroskedasticity test 52 4.3.3 Endogeneity test 53 4.3.4 Managerial entrenchment effect, firms’ histories and leverage ratio 54 Page | viii 4.4 The relationship of managerial entrenchment in both high and low entrenchment regime and firms’ histories on Vietnam firms’ leverage ratio 60 CHAPTER CONCLUSION AND POLICY IMPLICATIONS 66 5.1 Concluding remarks 66 5.2 Policy implications 69 5.2.1 Implications for Vietnam’s listed firms 69 5.2.2 Implications for Vietnam’s investors 71 5.2.3 Recommendations for the Government of Vietnam and relevant authorities 71 5.3 The limitation and further improvement 73 REFERENCES 74 Page | ix proxied by the difference between number of selling shares and number of purchased shares Share repurchase occurs when there is a reduction in stock prices while selling shares occurs when price increases (Seyhun 1986) The higher the stock prices are, the more the insider transactions mangers trade This means that equity issuing is preferred to debt financing In addition, since stock returns increase, shares appear to be more attractive to investors Consequently, managers decide to issue equity rather than debt financing, leading to a reduction in book debt ratio Fifth, leverage deficit is negatively significant related to leverage ratio This finding confirms that firms issue more equity than debt As such, current leverage ratio moves away from the target leverage level Change in target leverage, the speed of current target market leverage ratio away its previous target leverage is higher than that of book leverage ratio As a consequence, managers in Vietnam not follow the target leverage ratio Furthermore, findings from this study confirm the impact of high managerial entrenchment regime and low managerial entrenchment regime and firms’ histories on book leverage ratio and market leverage ratio The results confirm that high-entrenched managers pay attention on the market timing and benefit from the equity market As a result, they reduce a leverage ratio utilized in their firms The results indicate that the high managerial entrenchment regime includes larger number of block-holders, larger boards, older CEOs with CEO-Chairman duality and more outside directors Findings achieved from this study also reveal empirical evidence to support the view that the change of leverage ratio is a negative response to financial deficit, profitability (EBIT), timing measures – yearly timing and long-term timing and an alternative timing measure – insider sales, and stock price returns Considerably, the downward adjustment of debt ratio is affected by high-entrenched managers Nonetheless, high authority of entrenched managers to the board could be linked to weak corporate governance in the Vietnamese context This observation is based on the reports of International Finance Corporation and the State Securities Commission Vietnam (2006) and International Finance Corporation and the State Securities Commission Vietnam (2012) Page | 68 5.2 Policy implications This research is carried out to provide empirical evidence of the influence of managerial entrenchment and firms’ histories on leverage ratio for listed firms in Vietnam Empirical evidence is illustrated with main findings obtained from this study With the aid of the findings, some recommendations are made to policymakers in association with the Government of Vietnam and relevant authorities and Vietnam’s listed firms 5.2.1 The implications for listed firms in Vietnam To listed firms in Vietnam, varieties of proposals are provided to support the companies in achieving successful corporate governance framework and promoting their ability to compete with other enterprises  First, it is the high time for the companies’ top executives and the owners to lay emphasis on the vital presence of the boards’ members The members play an essential role on the development of the companies’ strategic planning and monitoring, and they also provide beneficial advice to achieve the firms’ objectives On the contrary, the members not have any power in relation to the fundamental corporate decisions when entrenched managers maintain their dominance of corporate determinations Hence, the executives and the owners should balance the pros and the cons of the power of entrenched managers  Second, the corporate governance principles (2004, 2015) and Vietnam corporate assessment report (2012) are important in the pursuit of successful corporate government instrument of Vietnam’s listed firms when taking advantage of the role of experienced outside directors on the boards The experienced outside directors are skilled in finance and possess relevant knowledge on the firms By virtue of the severity of separate power in listed firms, the primary strategic directions of the companies are considerably decided by entrenched managers rather than by board of directors, the firm’s benefits will be manipulated to support those managers’ interests With the aid of the proficiently external factors, the managements are under great pressure to faithfully comply with corporate governance mechanism, to limit managerial entrenchment and to maintain the owners’ interests Page | 69  Third, the definition of outside directors should be clearly identified by firms’ management The revision should follow Circular 121/2012/TT-BTC (dated July 26, 2012 and issued by the Ministry of Finance) which is a useful prescription for the management of public companies Since the managements take full responsibility for providing outsiders with tasks and supervising their performance, managers are capable of distinguish roles and responsibilities of independent directors from those of non-executive directors The presence of outside directors contributes benefits to the development of the strategy of the companies and gives rise to a decline in managerial entrenchment in order to promote companies’ market value  Fourth, findings from this study indicate that there is a negative effect of managerial entrenchment and market timing presented through firms’ histories on leverage ratio Managers with high entrenchment have more incentives to gain benefits from issuing equity rather than debt Those managers raise external funds with equity on the belief that they can successfully time the market and the costs of equity are more affordable than those of debt It is argued that the more the equity is issued, the larger the agency conflicts between the managements and the owners are When the equity issuing is preferred to debt financing, debtholders immediately receive unsecured message from those entrenched managers, activating information asymmetry and interest conflicts between the two parties In addition, since the securities market is unpredictable, the possibility of mispricing stock prices is validated and the probability of profits being cut deep from market timing wrongs is also verified Consequently, debtholders, shareholders, and firms’ value are all in the damage Thus, listed firms in Vietnam should strictly consider balancing the role of debt with the role of equity on making capital structure decisions Page | 70 5.2.2 The implications for Vietnam’s investors Findings from this empirical study are also to provide evidence for investors to consider their investment strategy in Vietnam’s stock market  The education of investors serves an indispensable role in developing the Vietnam’s securities market Especially, possessing a wide knowledge of relevant aspects of law on enterprises is a must to the investors in Vietnam With the help of improving understanding of the law, investors understand more clearly about their rights in order to protect themselves and their investments from interest of conflicts  Shareholders should request full disclosure of corporate documentations to get access to all restricted information in the past and to exam the operations of firms when managerial entrenchment occurs Additionally, the owners are capable to construct strict corporate governance mechanism and impose threat of firing on managers to limit the managerial entrenchment If shareholders not get compliance from management, they can sue those managers for covering information and preventing shareholders’ rights or they finally can refuse to invest in companies  To debtholders, they should carefully take a careful investigation on all investment projects Since entrenched managers manipulate leverage ratio to finance bad projects to benefit themselves, the creditors can raise interest rates to prohibit risks from the bad investments or they can put an end to debt financing 5.2.3 The recommendations to the Government of Vietnam and relevant authorities To the Government of Vietnam and relevant authorities, some following suggestions are proposed to fill in the legal gaps  First, the Government should not simply monitor all listed companies in both physical activities and financial management but also command these firms to strictly obey the law on enterprises and corporate governance framework Doing sure is to ensure that ignoring legal requirements and the framework will be detected so that the legal framework will be progressively adjusted, revised and completed Page | 71  Second, particularly, the Government and relevant authorities are required to complete Circular 121/2012/TT-BTC dated July 26, 2012 which is issued by the Ministry of Finance The Circular is a prescription for the company management applicable to public companies Although the interpretation of the document is plausible, the application has yet to be consistently and conveniently followed by companies For this reason, a more coherent and understandable resolution is urged to be completed  Third, the definition of outside directors should be explained more clearly in the regulations The general concept is not capable of providing a sufficient level of details in relation to roles and responsibilities of independent directors compared to those of non-executive directors on the boards The presence of outside directors is considered as a crucial role in fulfilling the development strategy of the companies and controlling payments and rewards of the executive directors As a result, managers are forced to conform to corporate governance mechanism and the managerial entrenchment effect possibly is lessened  Fourth, the Government should raise awareness of the severity of the boards’ separate power in Vietnam’s listed firms Since the primary strategic directions of the companies are substantially affected by entrenched managers rather than by board of directors, the firm’s benefits will be consumed to support those managers’ interests  Fifth, due to the effects of managerial entrenchment and market timing, the role of debt is not paid much attention in comparison with that of equity when firms raise external funds to finance investments However, the equityoriented governance virtually generates an unsafe signal to debtholders and triggers information asymmetry, enlarging interest conflicts among the managements and the owners Furthermore, as Vietnam’s securities market has reached an early stage of development, the information asymmetry and agency conflicts may considerably cause stock prices to be mispriced and firms’ value to be declined, leaving both debtholders and shareholders in ruin In this way, the policymakers are obligated to generate the availability of transparent market information and to improve the meticulousness of designed regulations Page | 72 5.3 The limitation and further improvement The research sheds light on the proposed questions and the impact of managerial entrenchment and firms’ histories on leverage ratio in the Vietnamese context – one of the typical representatives for emerging markets However, some limitations are still remained The quality of the dataset, to some extent, is not compatible with some of the research objectives First, the timespan of the sample is called for longer horizons in order to gain a better long-term estimation on the effect of corporate governance with managerial entrenchment factor and market timing via firms’ histories on firms’ leverage Moreover, since the observations only cover the ten-year period, ranging from 2006 to 2015, the significance of the relationship is probably influenced Second, the disclosure of corporate governance characteristics such as voting index, officer protection index and CEO protection index remains restricted owing to Vietnam firms’ culture of veiling information in secrecy Additionally, companies not strictly obey the law on enterprises in publishing accurate and adequate annual reports This possibly causes an effect on the reliability of estimations Third, findings from the research will considerably become more robust and persuasive when adding more developing countries sharing similar features with Vietnam Furthermore, the current weighted model has yet to resolve the differences among Vietnam’s listed firms; it somewhat leads to inefficient estimators Therefore, the alternative model is qualified to future research The impact of managerial entrenchment on financing decisions and the influence of market timing behavior through firms’ histories on leverage ratio have noticeably taken into account for a long period of time in some countries which have reached a fully development of securities market On the contrary, these issues have not been received much attention in Vietnam Despite the limitations, this research is conducted to lay the groundwork for future research on managers’ behavior towards determining crucial firms’ financing 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