Executive Summary
There exists or not an optimal capital structure to every business and if so, how its affect
to value firm is always an argumentative topic in the financial community over the past
decades. Capital structure has been an important focus point in the literature since Modigliani
and Miler (1958) have published their seminal research article, entitled “The cost of capital,
corporation finance and theory of investment” in the American Economic Review. The M&M
theory on capital structure claims that in an efficient market and in the absence of taxes,
bankruptcy costs, and asymmetric information, the value of a firm is independent of capital
structure.
Several theories have been developed in the attempt to arrive at one that is able to
explain the financing behavior of companies as well as establishing whether an optimal capital
structure exists. Theories such as agency theory (Jensen & Meckling, 1976) trade-off theory
(Modigliani and Miler, 1963) and Pecking order theory (Myer & Majluf, 1984; Myer, 1984),
with the latter two being the most dominant, have been developed and used in the attempt to
explain companies’ capital structure. The trade-off theory advances that the choice of capital
structure in a firm is a result of a trade-off theory between the benefits of debt, such as those
arising from interest debt tax shields, and the costs of debt, such as indirect and direct
bankruptcy costs (Myers, 1984), whereas the pecking order theory state that companies prefer
the cheapest source of funding, which due to information asymmetry, means companies prefer
internal to external funding as well as debt to equity funding (Myer & Majluf, 1984).
Numerous studies have carried out empirical tests of capital structure theories, trying to
establish whether they could explain the capital structure of company as well as figuring out
which determinants were important when considering companies’ capital structure in developed
countries and developing countries.
By learning about the situation of Vietnam businesses, I recognized Vietnam businesses
does not focus on building the capital structure consistent with its business, while enterprises in
developing countries, it is the first issue to decide for the formation and development of a
business.
To build an appropriate capital structure, Vietnam companies need to understand in such
conditions, their capital structure is subject to the impact of these factors. Our main objective is
to contribute to help Vietnamese businesses build an optimal structure, so I choose research
question “Indentify factors that affect the capital structure, inspection in Vietnam”.
This study used data from 88 non-financial companies listed on the Ho Chi Minh Stock
Exchange from 2008-2012, including 88 firms has largest market value by industry. All financial
data of 88 companies are derived from the financial statements on the website of these
companies.
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Synthesis and analysis of qualitative data combined with statistical analysis of
quantitative data, comparing the results obtained with the previous results have been presented
in order to clarify the research problem. Tool use econometric models run on software Stata11.
This study aims to help the managers and the scientists have the empirical evidence
about the factors affecting on the capital structure of listed companies on the Ho Chi Minh
Stock Exchange.
This study shows that: the factors that affect the capital structure of Vietnam firms are
profitability, tangibility, size, growth, liquidity; and the factors impact on capital structure
strongest is size, probability and liquidity, in which:
- Relationship between capital structure and profitability is negative
- Firms that are larger in size tend to have more leverage.
- Liquidity has negative correlation with total debt to total assets.
- Tang has negative correlation with short-term debt and positive correlation with long-
term debt.
- Firms with more growth opportunities tend to have more long-term debt
- State companies tend to use more leverage than other companies
The negative relationships between profitability and leverage; positive relationships between
growth and long-term debt are confirming the presence of Pecking-order theory in determining
the financing behavior of Vietnam firms. The strong positive relationships between size and
leverage support the theoretical predictions of Trade-off theory.
In addition, the research results show the company is listed on the HCM City Stock Exchange
to use less long-term debt, this can be explained by the corporate bond market in Vietnam has
not found development, should be funded by businesses dependent on equity, short-term loans
from banks and commercial credits. Design thinking for increased funding for many businesses
need to promote development of the corporate bond market.
Key word: “Capital structure”, “leverage”, “debt”,
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1. INTRODUCTION
1.1. BACKGROUND
In finance, the capital structure is the most debatable topic and continues to keep
researchers pondering. Capital structure refers to mix debt and equity used by a firm in
financing its assets. The capital structure decision is one of the most important decisions made
by financial management. The capital structure decision is at the center of many other decisions
in the area of corporate finance. These include dividend policy, project financing, issue of long-
term securities, financing of mergers, buyouts and so on. One of the many objectives of
corporate financial manager is to ensure the lower cost of capital and thus maximize the wealth
of shareholders. Capital structure is one of the effective tools of management to manage the cost
of capital. An optimal capital structure is reached at point where the cost of capital is the lowest.
Much on the empirical research on the determinants of firm’s capital structure has been
directed largely towards companies listed in developed countries, such as the US, UK and
Western Europe (Rajan and Zingales, 1995; Wald, 1999; Franck and Usha, 2002); little work
has been done to further our knowledge of capital structure within developing countries that
have different institutional structures. Recently, Booth et al (2001) provided the first empirical
study to test the explanatory power of capital structure models in developing countries. The
study used data from 10 developing countries to assess whether capital structure theory was
portable across countries with different institutional structures. It investigated whether the
stylized facts, which were observed from the studies of developed countries, could apply only to
these markets or whether they had more general applicability. The results were somewhat
skeptical of this premise. They provided evidence that firms’ capital choice decisions in
developing countries were affected by the same variables as they were in developed countries.
Nevertheless, there were persistent differences of institutional structure across countries
indicating that specific country factors were at work. Their findings suggest that although some
of the insights from modern finance theory are portable across countries, much remains to be
done to understand the impact of different institutional features on capital structure choices.
Booth et al. (2001) selected countries operating a market-orientated economic system,
which bore many similarities to developed countries. It is interesting and important to know
how capital structure theories work in a transitional economy environment within which
institutional structures differ not only from developed countries but also from developing
economies. Vietnam is the developing and transitional economy in the world, and therefore is
chosen as the focus of this study. It is hoped to answer the questions as following:
- The impact of firm-specific factors on the capital structure of the Vietnam firms?
- What are the results that can be achieved from testing of variables indentified from
theories?
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- What variables can be derived from the theories of capital structures?
1.2. RESEARCH OBJECTIVES
In short, the purposes of the research are:
(1) An overview of the theory of capital structure in order to see the importance of an
optimal capital structure, the rationale for the development of the business in the long term.
(2) To understand the factors that affect the capital structure of a business is a lot of
researchers to analyze and debate to see the direction the impact of these factors on the capital
structure of a business.
(3) To survey and provide empirical evidence for the impact of these factors in Vietnam
through surveys capital structure of listed companies on the stock exchange in Ho Chi Minh
City (HOSE) in the economic model amount, then gives an overview of and practical capital
structure for Vietnamese business.
1.3. OUTLINE STRUCTURES
The remaining part of the thesis is structured as follows. Section Two offers a literature
review on capital structure, capital structure in financial theory and empirical evidence, and an
overview of Vietnamese economy. Section Three provides research methodology; with
characteristic of Vietnam’s stock market, data collection and the last discuss the practical
method used in order to conduct the econometric analysis of Vietnam listed companies’ capital
structures. Section Four present, discuss and evaluates the findings. Section Five conclusion and
recommendation the study.
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2. LITERATURE REVIEW
2.1. CAPITAL STRUCTURE
Capital structure is the mix of financial instruments used to finance real investments by
corporations. Capital structure mention to the way businesses seeking financing through a
combination of plans to sell shares, options to purchase shares, bonds and loans. Optimal capital
structure is the plan, which is now the smallest capital cost and highest stock prices.
A capital structure is consistent with all important decisions by businesses not only need
to maximize the benefits obtained from individuals and organizations related to business and
business activities, but also by the impact of this decision to the business capability of
enterprises in the competitive environment.
Optimal capital structure involves trade-offs between costs and business benefits.
Financing with loan capital created "tax shield" for businesses, while reducing the level of
dispersion management decisions (especially with a limited number of business opportunities
and investments). The burden of debt, on the other hand training is offered to business
pressures. Funding from the share capital does not create user cost of capital for businesses.
However, shareholders may intervene in business activities operating high expectations on the
efficiency of production and business investors also create considerable pressure for managers.
Capital structure has been an important focus point in literature since Modigliani and
Miler stated publishing their research about it in 1958 and 1963, with the following
assumptions:
- No transaction costs
- No bankruptcy costs
- Firms issue only two types of claims: risk-free debt and equity
- Capital markets are complete
- Capital markets are competitive (individuals and firms are price takers)
- No taxes
Under the above set of assumptions, Modigliani and Miler showed that:
- Proposition I: A firm’s total market value is independent of its capital structure
- Proposition II: A firm’s cost of equity increases linearly with debt-equity ratio
During the decades which have passed since the emergence of Modigliani and Miler’s
propositions regarding capital structure, a vast amount of research, in somewhat different
directions, have added quite a bit of new knowledge in the discussion regarding capital
structure, which will be reviewed in this chapter. The starting point of that will be to look at
what could argued to be “mainstream” financial research in the field of capital structure, post
Modigliani and Miler.
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2.2. CAPITAL STRUCTURE IN FINANCIAL THEORY
Taking its theoretical point of departure mainly from what could be defined as traditional finance
discourse, a number of newer theories, at least in comparison to the Miller and Modigliani
propositions, have in recent decades emerged for explaining a company’s choice of capital
structure. The ones reviewed in this section will be the trade-off theory, the agency cost theory
and the pecking-order theory.
2.2.1. THE TRADE-OFF THEORY
The trade-off theory explains firms’ choice of leverage by a trade-off between the benefits and
costs of debt. A trade-off of costs and benefits of borrowing, holding the firm's assets are viewed
as determiner of a firm’s optimal debt ratio. Main focus of a firm is to substitute debt for
equity, vice versa in order to find optimal debt ratio and maximize value of the firm.
Hence, trade-off theory can be summarized as balancing the different benefits and costs
associated with debt financing to have optimal capital structure. Debt also has disciplining
role because of reduction in free cash flow (Myers, 1984, p.577-578).
When a firm adjusts the optimum debt ratio, costs, and therefore lags, which are called as
adjustment costs, make optimal capital structure of each firm different (Myers, 1984, p.576).
Graham and Harvey (2001) suggest that firms need to identify their optimal capital structure and
endeavor to reach and keep it. As it is understood, there is large deviation in optimal capital
structure among firms.
Tax shield is also important point of the theory. Firms can deduct interest payment of debt from
tax, as a result net incomes of the firms increase. In order to maximize tax shield, firms may
choose higher debt levels (Graham, 2000, p. 1906). Therefore, firms with higher debt are
expected to have better financial performance. However, high amount of debt may cause risk of
bankruptcy and raising agency costs occurring between owners and managers (Brealey and
Myers, 2003). As it is seen, the theory does not only explain taxes and tax shields but effect of
financial distress due to high leverage. It propose that firm’s target capital structure is designed
by taxes, financial distress (cost of bankruptcy), and the agency conflict (Graham, 2000, p.
1907).
According to trade-off framework, firms set a target debt-to-value ratio and gradually moving
towards it, in much the same way that a firm adjusts dividends to move towards a target payout
ratio (Myers, 1984, p. 576). Many studies also support this framework such as Hovakimian,
Opler and Titman (2001), Fama and French (2002) Gaud, Jani, Hoesli, and Bender (2005),
Smith and Watts (1992), Byoun and Rhim (2003). These studies propose that firms move
towards their target ratio over the long run or the short term and the target debt ratio and actual
debt ratio is an important aspect to take into consideration.
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2.2.2. THE AGENCY COST THEORY
Jensen and Meckling (1976) who are founders of the agency cost theory, subsequently define the
agency relationship inside the firm as: "A contract under which one or more person (the
principal) engages another person (the agent) to perform some service on their behalf which
involves delegating some decision making authority to the agent”.
According to the agency theory, the way of professional management style, which is the
separation of ownership and management may result agency conflicts that is caused by
insufficient work effort of manager, indulging in perquisites, choosing inputs or outputs
according to one’s preferences. Due to these reasons, a firm may fail to maximize its value.
Conversely, with these reasons one can maximize his/her own wealth and utility (Berger &
Bonaccorsidipatti, 2006).
However, the theory suggests that choosing best/optimal capital structure may mitigate agency
conflicts and decrease agency cost. Therefore, according to the theory, high leverage/debt ratio
help a firm to reduce its agency cost and mitigate agency conflicts. This debt ratio also
encourages managers to act more in the interests of shareholders. As a result, the firm’s value
increases.
2.2.3. THE PECKING-ORDER THEORY
The so called pecking-order theory or pecking-order hypothesis was developed by Stewart
Myers in 1984, as a way of describing the corporate finance behavior that he has observed
and based on that he pointed out three major points that corporate finance managers tends to
adhere to and that is highly relevant for capital structure choices. Myers’ (1984, p. 581) three
points are provided below:
1) Managers want to maintain stable shareholder dividends over time, despite possible
fluctuations in earnings, stock prices or investment opportunities.
2) Mangers prefer internal financing compared to external financing, i.e. funds which are raised
through the issuing of new either debt or equity shares.
3) If external financing is necessary, managers opt for the least risky option first and so on.
Myers ranks different securities based on their perceived riskiness, with going from straight debt
on one end of the spectrum, through common stock on the other end.
Thus it is argued that corporate financing behavior are a result of information asymmetry and
that investors are under informed about the value of projects within a company for instance,
leading to that the company surrenders a substantial amount of a projects net present value to the
investors, when utilizing external financing, particularly external equity financing. This is
because the cost of debt financing is smaller than equity financing, as the differences in the
market’s and the management valuation of it are smaller than in the case of equity financing. To
avoid getting into this scenario with external financing however, it is argued that companies
maintain financial slack at all times, thus being able to internally finance its profitable projects.
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Financial slack as such could be defined as cash and marketable securities that the company
holds (Myers, 1984, p. 590)
2.3. EMPIRICAL EVIDENCE
After knowing theories of capital structure we need so see how much research work has been
done on capital structure with regard to justify the predictions of these theories by collecting
empirical evidence from all around the world. Is there any difference between developed and
developing world with regard to source of finance? As mentioned below all the empirical
evidence in the literature of capital structure subject to specific condition in which prediction of
some theories work while hypothesis of other theories do not. Likewise the behavior of firms to
adjust the capital structure is changing when they are confronted certain internal (company
specific) and external (outside of the firm) situation. Myers (2001) states all three theories of
capital structure are conditional because they work under their own set of assumption. It means
none of three theories can give vivid picture in practicing the capital structure. Eldomiaty and
Ismail (2009) argue that in practice, business conditions are dynamic that cause firms changing
their capital structure thus moving from one theory to another, for example, when the tax rate
increases firms issuing debt for taking advantage of tax shield (Trade-off theory). When debt
becomes less attractive to issue then firms may seek financing from retained earnings (Pecking-
order theory).
Cook and Tang (2010) posit well macroeconomic conditions help firm to adjust capital structure
toward target quicker than that in bad macroeconomic conditions. Korajczyk and Levy, (2003)
argue that ―our results support the hypothesis that unconstrained firms time their issue choice
to coincide with periods of favorable macroeconomic conditions, while constrained firms do
not. Barry et al (2008) argue that interest rate affects the leverage; firms issue more debt when
interest rate is low as compare to its historical level. Hennessy and Whited (2005) argue more
liquid firms hold lower level of leverage. They say debt issue is more attractive when it is used
to purchase back equity than when borrowed amount is distributed in shareholders.
There can be many economic (country specific) factors such as GDP growth, interest rate,
inflation, capital market development and situational factors which directly or indirectly affect
the capital structure of the firm. Graham and Harvey (2001) depict that firms consider the 17
price appreciation of share before issuing it, and debt rating and financial flexibility before
issuing debt. Miao (2005) claims to introduce competitive equilibrium model of capital
structure and industry dynamics, and says firms make capital structure decision on the basis of
peculiar technology shocks.
2.3.1. EVIDENCE FROM DEVELOPING COUNTRIES
Relatively little research work on firms’ financing decision has been done in developing
countries (Shah & Khan, 2007). The main difference between developing and developed world
is that in developed world firms finance their leverage with long term debt and short term debt
is mainly contributing in leverage of firms in developing world (Booth et al 2001). Tong and
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Green (2005) inspect capital structure of listed Chinese companies and find evidence in the
support of pecking order theory (Cobham & Subramaniam, 1998). Huang and Song (2006)
examine capital structure of 1200 Chinese firms and find the results consistent with Trade-off
theory and Pecking order theory of capital structure. Eldomiaty and Ismail (2009) examine the
capital structure of Egyptian firms and find the evidence supporting Trade-off theory.
Gurcharan, (2010) examines the capital structure firms in selected four developing ASEAN
countries and finds significant negative relationship between profitability and growth in all four
counties but other determinants of capital structure are treating differently in each country.
Booth et al (2001) investigate capital structure of 10 developing countries and argue that there is
negative relationship between tangibility and leverage in Pakistan, Brazil, India and Turkey
unlike the corresponding results in G7 by (Rajan & Zingales, 1995). While investigating capital
structure of Pakistani companies (Shah and Hijazi 2004) also do not find significant relationship
between tangibility and leverage. Chakraborty, 2010) argue the positive relationship between
tangibility and leverage of Indian firms. Booth et al (2001) and (Shah and Hijazi, 2004) find
evidence supporting pecking-order theory. As mention above, evidences in developing world
indicate the dominancy of pecking order theory as compared to trade-off theory.
2.3.2. EVIDENCE FROM DEVELOPED COUNTRIES
It has been unanimously observed that most of the empirical research on corporate capital
structure is conducted in developed world (Mazur, 2007). Margaritis & Psillaki (2007)
investigate capital structure of 12,240 firms in New Zealand and find evidence consistent with
agency cost model. Frank & Goyal, (2009) examine capital structure of publically traded
American companies from 1950 to 2003 and find the evidence supporting some versions of
trade-off model. Beattie et al (2006) conducted survey research in which they examine the
capital structure of listed UK firms and evidence support the predictions of trade off theory as
well as pecking order theories. Huang & Ritter (2009) argue that US firms finance their
operations more with external equality than debt if cost of equity capital is low. Lipson &
Mortal (2009) investigate the relationship between liquidity and capital structure of US firms
and find negative relationship between liquidity and debt. Cook & Tang (2010) investigate the
financing behavior of US firms in good and bad economic condition and find that US firm
adjust their capital structure more quickly in good economic condition than bad. Antoniou et al
(2008) investigate capital structure of firm and find the evidences supporting Pecking-order
theory and Trade-off theory of capital structure. Bancel & Mittoo (2004) conduct survey in 16
European countries and find the evidences consistent with Trade-off theory of capital structure.
Rajan & Zingales (1995) investigate the capital structure of firms in G7 countries and find the
similar treatment of variables of capital structure in all seven industrialized countries. Brounen
et al (2006) conducted survey to investigate the capital structure of firms in Europe and find the
evidences consistent with pecking order theory. Allen & Mizuno (1989) examine the financing
decision of the Japanese firms and find evidences consistent with pecking order theory. Pushner
(1995) 18 analyses the capital structure of Japanese firms and finds evidence consistent with
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agency cost theory. The evidence from Switzerland also supports pecking order and trade-off
(Drobetz & Fix, 2005).
2.4. OVERVIEW OF VIETNAMESE ECONOMY AND STOCK MARKETS
From 2007 to 2012 is the period witnessed a lot of volatility in the economy in general and
Vietnam Vietnam's stock market in particular. Therefore, the capital structure of firms in the
market is more volatile due to the economy. During this period, the capital structure of the
business by the book value (long-term debt on the book value of equity) generally range from
10% - 15% and the variation between the year is not too large. However, the capital structure of
the market value (long-term debt ratio on market value of equity) have very large fluctuations
between years and reflects more clearly the impact of the economy the capital structure of the
business. Although the value of the book or market value of the overall capital structure of
Vietnam enterprises have long-term debt ratio is not too high (below 15%). This shows that
Vietnam now mainly used by owners of capital (equity) rather than debt.
In 2007 was a year of prosperous development of Vietnam's economy with GDP growth rate of
8.48% annually on average, macroeconomic stability, the base rate of the period was 8.25%.
This period of development is very favorable for most businesses in the Vietnam market.
Especially in 2007, there are many businesses successful IPO, sold 100% of the issued shares
and earned huge surplus stock. It's a great motivation boost Vietnam businesses continue to
grow. Businesses tend to use more equity than debt to financial leverage tends to decrease. In
terms of book value, long-term debt in 2007 is 12.77%, based on market value; long-term debt
in 2007 was 8.1%.
After a period of prosperity, in 2008, brought to Vietnam market more "waves" with the global
financial crisis to make people spend limited countries making enterprises in the field of import
Shedding border. At the same time, rising domestic inflation (22.97%), so the base rate also
increased (12% - 14%) and reduced GDP growth (6.23%). As investors lost confidence in
Vietnam's stock market, the VN-INDEX plummeting (from 1100 peak of 2007, the VN-Index
dropped to 286 in 2008). Stocks that depreciate businesses can not use the advantage of the
equity that can not borrow because interest rates fluctuate constantly due to the macroeconomic
policies of the government to stabilize the economy.
Expressed most clearly the devaluation of equity on the stock market as measured by the rate of
long-term market value. Long-term debt ratio calculated as the average market value in 2008
increased the number of years of mutations observed (17.06%). The cause of this sudden
increase is due to the devaluation of equity investors lost confidence in Vietnam's stock market,
many investors withdraw capital or sell-off led to the collapse of the market school.
2008 also began a difficult period of Vietnam's economy in the years that followed. 2009 and
2010, thanks to the stimulus package, lending support of the government of Vietnam to
implement corporate restructuring towards capital-intensive rather than capital-intensive
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