Investment decision of fdi firms in Vietnam under uncertainty of carbon taxation

MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY LE QUOC THANH INVESTMENT DECISION OF FDI FIRMS IN VIETNAM UNDER UNCERTAINTIES OF CARBON TAXATION The Dissertation of Economics Major: Finance & Banking (9340201) HOCHIMINH CITY - 2019 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY LE QUOC THANH INVESTMENT DECISION OF FDI FIRMS IN VIETNAM UNDER UNCERTAINTY OF CARBON TAXATION The Dissertation of Economics Major: Finance & Banking (9340201) HOCHIMINH CITY - 2019 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY THE DISSERTATION OF ECONOMICS INVESTMENT DECISION OF FDI FIRMS IN VIETNAM UNDER UNCERTAINTY OF CARBON TAXATION Major: Finance & Banking (9340201) Scientific Instructors: Associate Prof.Dr Nguyen Huu Huy Nhut Dr.Pham Quoc Viet HOCHIMINH CITY – 2019 iii ACKNOWELEDGES My name is Le Quoc Thanh, PhD student in the major of Finance-Banking at University of Economics Hochiminh City I have developed my thesis under the instructions of Associate Prof.Dr Nguyen Huu Huy Nhut and Dr.Pham Quoc Viet I would like to confirm that the research results in this thesis is from my own works and has not been published PhD Student Le Quoc Thanh iv TABLE OF CONTENT Additional cover Acknowledgements Table of content Abbreviation List of Tables and Diagram/Graphs ABBREVIATION VII LIST OF TABLES AND DIAGRAM/GRAPHS VIII ABSTRACT IX CHAPTER 1: OVERVIEW OF RESEARCH 1.1 Research setting and motivations 1.2 Research targets and research questions 1.2.1 Research targets 1.2.2 Research questions 1.3 Research objectives and scope of research 1.3.1 Research objectives 1.3.2 Scope of research 1.4 Methodology 10 1.5 Expected outcomes of the thesis: 11 1.6 Structure of the thesis 12 CHAPTER 2: THEORETICAL FRAMEWORK AND EMPIRICAL EVIDENCES 14 2.1 The firm and investment operation 14 2.1.1 The rationality of the firm’s investment decision 14 2.1.2 Methods of project appraisal 19 2.1.3 Uncertainty and risk 22 2.1.4 Classification of investors based on risk response 26 v 2.2 Foreign direct investment and its impact factors 28 2.3 Irreversible project 31 2.4 Investment decision under uncertainties 42 2.4.1 Theorectical studies of investment decision under uncertainty 42 2.4.2 Empirical studies of investment decision under uncertainty 45 2.5 Investment decisions under carbon taxation uncertainties 47 2.5.1 Carbon taxes and carbon leakages 47 2.5.2 Taxpayers and rates of carbon tax 52 2.5.3 Investment decision under carbon taxation uncertainties 54 2.6 Research gaps 56 2.6.1 Research gap 56 2.6.2 Research gap 58 2.7 Conclusion of Chapter 60 CHAPTER 3: RESEARCH METHOD 62 3.1 Selection of research methods 62 3.2 Research model 64 3.3 Model development based on risk response of investors 67 3.4 Optimization techniques by math 69 3.5 Simulation of research results 70 3.6 Simulated data 72 3.7 Conclusion of Chapter 72 CHAPTER 4: INVESTMENT DECISIONS UNDER UNCERTAINTIES OF CARBON TAXATION 73 4.1 The Basic model 73 4.2.1 Modeling the case of non-carbon taxation 75 4.2.2 Modelling the case of carbon taxation 78 4.3 The ratio of capital/labor in case of carbon and non-carbon taxation 81 4.4 Modeling the case of uncertain timing in application of carbon taxation 82 4.4.1 The Government does not announce timing of carbon taxation: 83 4.4.2 The Government announces application timing of carbon taxation at the year nth 84 4.5 Modeling the case of investors with different technology level 85 4.5.1 The case of non-carbon taxation 86 4.5.2 The case of carbon taxation 88 vi 4.6 Numerical results of simulation from the case of carbon and non-carbon taxation 91 4.6.1 Assumed data 92 4.6.2 Numerical results by graphs 92 4.7 Conclusion of Chapter 93 CHAPTER 5: POLICY AND MANAGERIAL IMPLICATIONS 95 5.1 General conclusions 95 5.2 Policy and managerial implications 97 5.2.1 Policy implications 97 5.2.2 Managerial implications 99 5.3 Research limitations and recommendation for further research directions 100 5.3.1 Research limitations 100 5.3.2 Recommendation for further research directions 100 REFERENCES 102 APPENDIX 114 APPENDIX 115 APPENDIX 121 vii ABBREVIATION ACCA The Association of Chartered Certified Accountants B/C Benefit/Cost BCC Business Cooperation Contract DCF Discounted Cash Flow FDI Foreign Direct Investment GDP Gross Domestic Products GNP Gross National Products IRR Internal Rate of Return K Capital Stock L Labor level M&A Merger & Acquisition NPV Net Present Value PMI Project Management Institute 𝜫 Firm’s Profit Function π Yearly firm profit ROA, RO Real Option Analysis, Real Option UNCTAD United Nations Conference on Trade and Development V Value of the firm WACC Weighted average cost of capital viii LIST OF TABLES AND DIAGRAM/GRAPHS Table 2.1.4 Classifying investors according to risks ……… ……………….27 Table 2.3 Project classification…………………… ……… …………… 32 Diagram 2.1 Typical Project Lifecycle ……………………………………….36 Table 2.4 Summary of related theoretical/empirical studies on investment decisions under uncertainties …………………… …………… 46 Table 4.1 Summary of abbreviation using in Chapter …….…………… 73 Table 4.6.1 Assumed Data for Simulation…………… ……….……………92 Table 4.6.2 Calculated results for optimum value of K*, L* and Π*……….93 ix ABSTRACT The thesis: "Investment decisions of FDI firms in Vietnam under uncertainty of carbon taxation " takes Vietnam as a typical one, aims to study the impact of uncertainties related to the carbon taxation on the investment decision and the choices of capital/technology level and the labor level of the FDI firms into the large asset project (also known as irreversible project) in Vietnam The thesis focuses on building the theoretical model based on the basic model of corporate profit function (Varian, 1992), reflecting the relationship between firm’s profit and main inputs such as capital/technology (K) and labor (L), and other costs, including carbon taxation costs Theoretical model was developed using optimization algorithms and simulations using hypothetical approximate data The thesis provides theoretical findings that the application of carbon taxation has the negative effect that lowering the investment level of the firm, however, at the same time, it also has the positive effect of restricting investors with low technology level and encouraging investors with higher technology level at the same carbon tax rate Thus, if the carbon tax is used as a regulatory tool, the government may develop policies that will encourage high-tech investors leading to the higher quality of foreign investment in Vietnam Key words: profit function, investment decision, irreversible project, uncertainty, capital/technology and labor, optimization the firm behaviors in investment decision If the research results of mathematical modeling are accepted, there will be able to expand to other uncertainties affecting the firm profit and thank to its results, we could design additional and suitable policies to reduce both uncertain level of and number of uncertainties which help increasing FDI instead of using the traditional solutions such as tax reduction, lower land rentals, etc In another hand, this thesis also provides a new idea that the carbon taxes could be used to reduce lower technology investors while encouraging the higher ones If the profit function of the firm including production and cost functions is to be in the form of Cobb-Douglas with K, L, it will allow the examination of relationship between K, L and carbon taxes Therefore, we could develop the model reflecting such above relationship (K, L and carbon taxes) so that we could design the tax policies as the main tools to navigate the firm’s behaviors in choosing K, L, etc Conditions of this type of research model needs to be assumed reasonably and close to practices so that the model shall be practically viable As the result, policy application of carbon taxation can be designed to increase the level of capital stock in 26 FDI project, leading to higher technology level At the present time, there is likely no economic measure which can navigate technology level of FDI project The government bodies purely use the administrative manufacturer’s certificates measures such which as are certificate based of on origin, manufacturer’s catalogues and some qualitative criteria to evaluate the second hand equipment to be imported into FDI projects in Vietnam These measures are purely administrative ones which could violate the commitments of WTO In addition, it could allow the corruption in approving incentives and licenses to FDI projects Under different modeling cases involving uncertainties of carbon taxation affecting investor profitability, the results of algorithmic modeling and calculations show the interesting implication as follows Firstly, when comparing two cases with and without carbon taxation, it is clear that the application of carbon taxation will reduce the investor's optimal capital stock and labor level (Theory 1) However, the optimal capital/labor ratio in the case of carbon tax is higher than that of the case without carbon tax, suggesting 27 that carbon taxation is effective to increase technology level in their project (Theory 2) Secondly, when investors consider investing in a non-carbon taxed country, they will concern the uncertainties of carbon taxation such as: when will the government apply carbon tax? For the investor who is not risk taker, they will determine the worst case: the government will apply carbon taxation as soon as on the first year of their project life cycle Therefore, they will choose low optimal capital/ technology and labor levels which are equal to case of carbon tax applied (Theory 3) Thirdly, when the government has applied carbon taxation that will tends to lead investors with lower carbon emission rate investing at the higher ratio of capital/labor in comparison with that ratio of higher carbon emission investor (Theory 4) Specifically, the answers for two research questions come as follow: (1) What are effects of carbon taxation uncertainties on investors’ investment decision in irreversible FDI projects? There are two uncertainties of carbon taxation in this study: level of 28 carbon taxation (Section 4.2) and timing application of carabon taxation (Section 4.4) Both uncertainties have same negative effects on capital and labor levels selected by investors in irreversible FDI projects which emit carbon dioxide The carbon taxation, if applied, will have negative effect on capital and labor level as it makes the investors to decide lower level of both capital and labor (2) What are the levels of capital per labor selected by the investors in irreversible FDI projects under uncertainties of carbon taxation? Under certain conditions as assumed in modeling parts, the level of technology measured by the ratio of capital per labor is increased when applying carbon taxation (Section 4.3) In addition, when level of carabon taxation is increased, the lower carbon emission investors likely to invest higher technology level than the lower carbon emission investors (Section 4.5) All of above findings are based on mathematical modeling and calculations which are based on a number of reasonable assumptions Therefore, it is necessary to further developed in different cases of assumed conditions so that the modeling results 29 would be more mathematically reliable and then, the model could be reasonably suitable for empirical testing 5.2 Policy and managerial implications From the results of model development and calculations in different cases of carbon taxation related uncertainties affecting project profits, we could develop some policy implications as follows 5.2.1 Policy implications + Should the government to apply carbon taxation? This question is still controversial among policy makers as the the carbon tax would reduce capital level in FDI project as showed by modeling results in Section 4.2 However, as calculated results in Section 4.3, the technology level in case of application of carbon taxation is higher Therefore, it could be a trade-off between lower investment capital and higher technology level Depending on priorities of country, the policy makers could decide to apply carbon taxation or not However, it is unclear in this research that at what level of carbon taxation on which the trade-off between application of carbon taxation and reduction in 30 FDI could be equal This is one of limitations in this research and it could be interesting topics for further research + Policy to attract FDI The government should inform in advance their schedule of imposing carbon taxation and possible carbon tax rates It will help investors reducing uncertainties related to carbon taxation As a result, the investors will make better investment decisions at higher capital stock and labor levels than the case that the government does not inform advance The advance notice of the possibility of applying carbon taxes should be formulated based on scientific foundation of signaling theory and information asymmetry, to ensure that investors are gradually receiving the information related to the process of preparing and imposing carbon tax, expected tax rates, taxpayers, tax bases, etc At the same time, it is expected that the estimated tax rate should be notified as soon as possible to help investors who are preparing to invest with enough necessary adjustment time With the taxpayer who already has operated, it is difficult to change the technology and thus, it is necessary to consider partial 31 exemptions, according to the roadmap to help firms adjust gradually to new costs for carbon taxes To reduce the risk to investors in terms of carbon tax rates, governments need to actively study regional and international carbon tax rates in order to provide a reasonable carbon tax rate to investors, still ensuring the regional competition in investment attraction + Attracting high technology investors for better environment: Carbon taxation should be considered to apply in order to limit low-tech investors (expressed as carbon emission rate) When applying carbon taxes, the high-tech investors (with lower emission rates) tend to invest at higher in capital / labor than in low-technology investor (higher emission rates) Therefore, the government may consider to set up carbon tax rate at the threshold level that will allow investors at the certain level of technology (certain level of carbon emission rate) to invest and eliminating the investment from lower technology investors 32 5.2.2 Managerial implications Firstly, managers/CEO should bear in mind that uncertainty is different from risk Not all uncertainties become the risks and they could make influence to clarify uncertainties to be risk or nothing Therefore, the management view for uncertainty should be different from risk is that firstly we must spend efforts to clarify information relating to uncertainty as much as possible and if it could become the risk, then we move to risk management technique Secondly, the uncertainties related to carbon taxation clearly influence the investment decision of the firm and the choices of optimum level of capital and labor in the project to ensure that the firm will achieve profit maximization Therefore, the manager needs to incorporate uncertainties related to carbon taxes in the project profit model for better project appraisal In addition, the selection of optimal capital in large projects is a very complex task, initially requiring the technical design, cost estimation and forming of the initial investment capital of the project Managers should identify and clarify uncertainties related to carbon taxes 33 and other uncertainties as soon as possible in the project preparation time, so that helping preparation works of the project, in particular to form the total initial investment cost more efficient Then, the results of NPV, IRR and/or ROA will be more exact for project appraisal 5.3 Research limitations and recommendation for further research directions 5.3.1 Research limitations This is a study that focuses on theoretical research and uses hypothetical simulation to illustrate the results of the mathematical modeling Then, the hypothetical data is employed to illustrate the theoretical results better However, the hypothetical data cannot replace empirical data Therefore, before applying the results of this research into reality, it is necessary to carry out additionally empirical research to calibrate theoretical results The responses of investors with carbon taxation related uncertainties are different depending on their psychological characteristics such as risk taker, risk neutral or risk adverse This thesis does not include such characteristics in the research model, but assuming that all investors are equal in risk tolerance 34 5.3.2 Recommendation for further research directions In addition to further researches to overcome the limitations of the thesis, the following research directions need to be taken into account in practical requirements in Vietnam Firstly, it may be necessary to develop deeper into the methods of project appraisal, in particular the method of real option analysis as it has been proposed by many scholars in the world for its benefit in case of project appraisal for large fixed assets Case studies of project appraisal in Viet Nam should be developed through combined data (collected and assumed ones) for certain types of projects Thank to these empirical studies, we may have the basis for proposing a formal appraisal method of real option in Vietnam in addition to the traditional one of DCF method Secondly, the next research direction should be to study how to design the optimal level of carbon tax or at what level of carbon tax to eliminate low technology investors with high carbon emission level If this research direction could be successful, it is possible to propose an important policy that would use carbon 35 taxes as regulatory instrument to regulate technology and labor levels in investment project in Vietnam, especially for FDI project Thirdly, the basic research model is static in short run and it could be more interesting if we could develop it under dynamic form in long run It could be more complicated in case of dynamic model, however, in the long run, when the increase in labor wage affecting technology choice of investors, we could find more interesting things which could be useful for policy implications regarding carbon taxation 36 LIST OF PUBLICATIONS OF AUTHOR (RELATED TO THE THESIS) ARTICLES - Lê Quốc Thành (2018) Các nhân tố bất định ảnh hưởng đến định đầu tư dự án FDI hủy ngang Việt , số 48 Th ng n m 20 Nam - Phạm Khắc Quốc Bảo & Lê Quốc Thành (2019) Thẩm định dự án không hủy ngang điều kiện bất định: Trường hợp bất định thuế carbon , Số 49, Th ng n m 20 SEMINAR - Wei Zhou, Stefano Bosi & Le Quoc Thanh (2016), Carbon optimal taxation and carbon emission leakage Hội thảo VEAM 2016, t Nẵng Accessed on 15/12/2019 at http://veam.org/the-previous- meetings/workshop-2016/program-workshop-2016/ 37 Đà CỘNG HÒA XÃ HỘI CHỦ NGHĨA VIỆT NAM Độc lập - Tự - Hạnh phúc TP Hồ Chí Minh, ngày tháng năm 2019 TRANG THƠNG TIN VỀ NHỮNG ĐÓNG GÓP MỚI VỀ MẶT HỌC THUẬT, LÝ LUẬN CỦA LUẬN ÁN Tên luận án: Quyết định đầu tư doanh nghiệp FDI Việt Nam điều kiện bất định thuế carbon (INVESTMENT DECISION OF FDI FIRMS IN VIETNAM UNDER UNCERTAINTY OF CARBON TAXATION) Chuyên ngành: Tài chính-Ngân hàng Mã số: 9340201 Nghiên cứu sinh: Lê Quốc Thành Khóa: 2015 Cơ sở đào tạo: Trường Đại học Kinh tế TP Hồ Chí Minh Người hướng dẫn luận án: PGS TS Nguyễn Hữu Huy Nhựt TS Phạm Quốc Việt Nội dung ngắn gọn đóng góp mặt học thuật, lý luận, luận điểm rút từ kết nghiên cứu, khảo sát luận án; Thứ nhất, luận án đề cập đến đối tượng nghiên cứu dòng vốn đầu tư cịn tìm hiểu sâu Việt Nam đầu tư tránh thuế carbon (carbon leakage) Thảo luận dòng vốn phần Tổng quan Nghiên cứu phần lý giải cho tượng thực tiễn nhiều dự án đầu tư nước Việt Nam gần dự án đầu tư vào ngành công nghiệp sắt thép, điện than, vật liệu xây dựng v.v, có mức phát thải cao Firstly, the thesis refers to the object of research as an investment capital under carbon leakage which is still not deeply understood in Vietnam Discussion of this capital flow in the Research Overview partly explains a phenomenon in practice that many foreign investment projects in Vietnam recently are in the field of basic and infrastructure industries such as iron steel, coal fired power, construction materials, etc., which is usually very high emissions Thứ hai là luận án phát khe hổng nghiên cứu có giá trị (1) nhà đầu tư từ nước phát triển có thuế carbon, dự kiến đầu tư vào dự án khơng hủy ngang có phát thải carbon nước chưa có thuế carbon, phản ứng với thuế carbon, loại thuế có khả áp dụng Việt Nam tương lai; (2) nhà đầu tư định đầu tư bối cảnh có thuế carbon nhà đầu tư lựa chọn mức công nghệ so với trường hợp chưa có thuế carbon Secondly, the thesis has discovered valuable research gaps, including (1) investors from developed countries where carbon taxation is available, are planning to invest in irreversible projects with carbon emission in non-carbon countries, how would they react to carbon taxes which could be applicable in Vietnam in the future; and (2) when investors decide to invest in the context of carbon taxation, what level of technology would the investor choose in comparison to the case of non-carbon taxation? Thứ ba luận án tập trung vào Nghiên cứu phát lý thuyết mơ hình tốn, phương pháp phổ biến giới học thuật, cịn hạn chế Việt Nam Thơng qua phần Tổng quan nghiên cứu, dựa công bố lý thuyết/thực nghiệm tạp chí uy tín, mơ hình nghiên cứu lựa chọn, phát triển áp dụng kỹ thuật tối ưu hóa (optimization technique), nhằm tính tốn kết dựa kết này, số định đề (lý thuyết) phát Cụ thể việc áp dụng thuế carbon nước phát triển Việt Nam, làm nhà đầu tư nước ngồi giảm quy mơ vốn đầu tư (K) tối ưu, nâng cao chất lượng công nghệ, phản ánh số Vốn/Lao động tăng Như vậy, kết luận thuế carbon giúp nâng cao chất lượng công nghệ dự án khơng hủy ngang có phát thải carbon Thirdly, the thesis focuses on identifying the theory by using mathematical model which is a popular method in the academic world, but still rarely applied in Vietnam Through the Research Overview, based on theoretical/empirical publications in prestigious journals, the research model was selected, developed by applying the optimization technique, to calculate the results Based on these results, some new propositions (theory) were discovered Specifically, the application of carbon taxes in developing countries like Vietnam, making foreign investors reduce the optimal level of capital stock (K), but improve the quality of technology, reflected by the increase in capital-labor ratio Thus, it can be concluded that carbon taxes help improve the quality of technology in carbon emission irreversible projects Thứ tư, so sánh phản ứng hai nhà đầu tư , có mức phát thải carbon thấp (cơng nghệ cao) nhà đầu tư có mức phát thải cao (công nghệ thấp) với mức thuế suất thuế carbon, cho thấy nhà đầu tư có cơng nghệ cao có xu hướng đầu tư quy mơ lớn so với nhà đầu tư có cơng nghệ thấp, thuế suất thuế carbon tăng lên Như vậy, giả định thị trường có hai nhà đầu tư với lượng cầu cố định, nhà hoạch định sách thiết kế mức thuế carbon ngưỡng làm giảm hoàn toàn đầu tư từ nhà đầu tư có lượng phát thải lớn nhờ tạo điều kiện tốt cho nhà đầu tư có cơng nghệ cao Fourth, when comparing the reaction of two investors, one has low carbon emissions (high technology) and investors have high emissions (low technology) with the same carbon tax rate, the thesis found that the high-tech investors will tend to invest on a larger scale than low-tech investors as the carbon tax rate rises Thus, assuming that in a market with only two investors with a fixed demand, policymakers can design carbon tax tariffs at thresholds that completely reduce investment from investors with high emissions Thus, it will create better conditions for high-tech investors Thứ năm, luận án áp dụng kỹ thuật mô dạng giản đơn mơ tính tốn lợi nhuận, vốn lao động tối ưu cho trường hợp thuế suất thuế carbon khác nhau, nhằm minh chứng cho kết phát lý thuyết từ phát triển mô hình kỹ thuật tối ưu hóa Fifthly, the thesis also applies simple simulation method which is simulated by calculation of optimal profit π, capital stock K, labor level L at different carbon tax rates, to demonstrate the results of discovered theories (proposition) from model development by optimization technique Thứ sáu cuối : thông qua phần tổng quan nghiên cứu, luận án thảo luận số vấn đề khái niệm quan trọng cho thực tiễn Việt Nam, như: (1) dự án đầu tư không hủy ngang mà hầu hết loại dự án dự án hạ tầng, lượng, dầu khí, sắt thép, giao thơng, …có tầm quan trọng thiết yếu đến kinh tế mạnh nào; (2) thảo luận việc phân tích thẩm định tài dự án dự án Real Option (RO) thay dừng DCF Nếu thực nghiệm hai phương pháp cho số dự án khác nhau, có nhận định RO nhằm đa dạng hóa phương pháp thẩm định tài dự án, thay đa số sử dụng DCF, dự án đầu tư công Sixth as final one: through the research overview, the thesis discussed some important issues and concepts for Vietnamese practice, such as: (1) irrevocable investment projects that almost all of these projects are infrastructure, energy, oil and gas, iron and steel projects that are of vital importance to any strong economy; (2) discussing the project financial analysis and appraisal by Real Option instead of only DCF as currently If it is possible to experiment these two methods for the same number of different projects, there may be new perspectives on Real Option to diversify project financial appraisal methods, instead of only DCF method, especially for public investment projects Nghiên cứu sinh ký tên Lê Quốc Thành Ghi chú: nghiên cứu sinh làm tiếng Việt tiếng Anh