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MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY --- oOo --- HUỲNH ANH KIỆT CAPITAL STRUCTURE AND FIRM PERFORMANCE: CASE STUDY: LISTED COMPANIES IN HOCHIMINH STOCK EXCHANGE MASTER THESIS Ho Chi Minh City – 2010 MINISTRY OF EDUCATION AND TRAINING UNIVERSITY OF ECONOMICS HOCHIMINH CITY --- oOo --- HUỲNH ANH KIỆT CAPITAL STRUCTURE AND FIRM PERFORMANCE: CASE STUDY: LISTED COMPANIES IN HOCHIMINH STOCK EXCHANGE MAJOR: BUSINESS ADMINISTRATION MAJOR CODE: 60.34.05 MASTER THESIS INSTRUCTOR : PROFESSOR NGUYỄN ĐÔNG PHONG Ho Chi Minh City – 2010 ACKNOWLEDGEMENT I would like to express my deepest gratitude to my research Instructor, Professor Nguyen Dong Phong for his intensive support, valuable suggestions, guidance and encouragement during the course of my study. My sincere thanks are also due to Dr. Vo Thi Quy and Dr. Tran Ha Minh Quan for their valuable time as the members of the proposal examination committee. Their comments and constructive suggestions were of great help in my completing this study. My sincere thanks is extended to Assistant Professor Nguyen Dinh Tho, Dr. Tran Ha Minh Quan, Dr. Truong Tan Thanh, Dr. Pham Huu Hong Thai, Dr. Bui Thanh Trang for their valuable time as members of examination committee. Their comments and suggestions were of great value for my study. I would like to express my sincere gratitude to all of my teachers at Faculty of Business Administration and Postgraduate Faculty, University of Econimics Hochiminh City for their teaching and guidance during my MBA course. I would like to specially express my thanks to all of my classmates, my friends from www.caohockinhte.vn for their support and encouragement. I would also like to avail this opportunity to express my appreciation to Professor Nguyen Dong Phong, UEH Board of Directors for creating MBA program in English and Dr. Tran Ha Minh Quan for his support during the course. Finally, I heartily dedicate this study to my beloved parents and my wife, Vu Thi Huyen who have always sacrificed to encourage and support me during my study. i ABSTRACT This study investigates the relationship between firm capital structure and firm performance. The author explores both the effect of firm performance on firm captial structure as well as the effect of capital structure on firm market performance using cross-sectional data representing of 162 Vietnamese companies in Hochiminh Stock Exchange for 2008. According to the results, a firm profitability is found to have a significant and negative impact on all firm capital structure. This finding support pecking order theory of Myers and Majluf (1984). An interesting finding is that firm size has a positive and significant impact on the leverage, which consistent with a previous study of Rajan and Zingales (1995), and indicating that a firm size is an important determinant of corporate capital structure. Firm capital structure is confirmed to have positive and significant impacts on firm market performance which is measured by Tobin’s Q. The author also finds that firm growth opportunities have a positive and significant impact on the firm value Tobin’s Q. Keywords: Capital structure, corporate performance, Vietnam, HOSE. ii TABLE OF CONTENTS ACKNOWLEDGEMENT .............................................................................................................i ABSTRACT .................................................................................................................................. ii TABLE OF CONTENTS ............................................................................................................ iii LIST OF FIGURES ....................................................................................................................... v LIST OF TABLES ........................................................................................................................vi ABBREVIATIONS ..................................................................................................................... vii CHAPTER 1: INTRODUCTION ................................................................................................ 1 1.1 BACKGROUND .......................................................................................................................... 1 1.2 RESEARCH PROBLEMS ........................................................................................................... 3 1.3 RESEARCH OBJECTIVES ......................................................................................................... 4 1.4 RESEARCH METHODOLOGY AND SCOPE .......................................................................... 5 1.5 STRUCTURE OF THE STUDY .................................................................................................. 5 CHAPTER 2: LITERATURE REVIEW .................................................................................... 7 2.1 INTRODUCTION ........................................................................................................................ 7 2.2 CAPITAL STRUCTURE ............................................................................................................. 7 2.3 FIRM PERFORMANCE ............................................................................................................ 11 2.4 HYPOTHESIS AND EMPIRICAL MODEL ............................................................................ 12 2.4.1. Model 1: The Leverage Model ......................................................................................... 12 2.4.2. Model 2: The Firm Value Model .....................................................................................15 CHAPTER 3: RESEARCH DESIGN ........................................................................................18 3.1 INTRODUCTION ...................................................................................................................... 18 3.2 DATA ......................................................................................................................................... 18 3.3 RESEARCH DESIGN ................................................................................................................ 18 3.3.1. Research Sample .............................................................................................................. 19 3.3.2. Data Analysis Method ...................................................................................................... 20 3.4 VARIABLES MEASUREMENT FOR MODEL 1 ................................................................... 20 3.4.1. Dependent Variables ........................................................................................................ 20 3.4.2. Independent Variables ...................................................................................................... 21 3.5 VARIABLES MEASUREMENT FOR MODEL 2 ................................................................... 21 3.5.1. Dependent Variables ........................................................................................................21 3.5.2. Independent Variables ...................................................................................................... 22 3.6 FRAMEWORK OF THE STUDY ............................................................................................. 23 3.7 SUMMARY................................................................................................................................ 24 CHAPTER 4: EMPIRICAL RESULTS OF THE RESEARCH............................................. 25 4.1 INTRODUCTION ...................................................................................................................... 25 4.2 CHARACTERISTICS OF RESEARCH SAMPLES ................................................................. 25 4.3 DESCRIPTIVE STATISTICS ................................................................................................... 26 4.4 REGRESSION ANALYSIS ....................................................................................................... 29 4.4.1. Model 1: The Leverage Model ......................................................................................... 29 4.4.2. Model 2: The Firm Value Model ..................................................................................... 32 CHAPTER 5: CONCLUSIONS, RECOMMENDATIONS AND LIMITATIONS ..............38 5.1 INTRODUCTION ...................................................................................................................... 38 5.2 CONCLUSIONS ........................................................................................................................ 38 iii 5.3 RECOMMENDATIONS............................................................................................................ 39 5.4 LIMITATIONS .......................................................................................................................... 40 REFERENCES ............................................................................................................................ 41 APPENDIX A ...............................................................................................................................44 APPENDIX B ............................................................................................................................... 45 APPENDIX C ............................................................................................................................... 51 iv LIST OF FIGURES Figure 1: The Leverage Model ........................................................................................ 14 Figure 2: The Firm Value Model .................................................................................... 17 Figure 3: Research Process .............................................................................................. 19 Figure 4: Framework of the study .................................................................................. 23 v LIST OF TABLES Table 1: Dependent variables for model 1...................................................................... 20 Table 2: Independent variables for model 1 .................................................................. 21 Table 3: Dependent variables for model 2...................................................................... 22 Table 4: Independent variables for model 2 .................................................................. 22 Table 5: Summary Statistics of the Explanatory Variables ......................................... 26 Table 6: Correlation Matrix of the Explanatory Variables for Model 1 ..................... 28 Table 7: Correlation Matrix of the Explanatory Variables for Model 2 ..................... 28 Table 8: Estimate Results for Model 1............................................................................ 29 Table 9: Estimate Results for Model 2 Using TDTA ..................................................... 32 Table 10: Estimate Results for Model 2 Using TDTE ................................................... 33 Table 11: Estimate Results for Model 2 Using LTDTA ................................................ 34 Table 12: Estimate Results for Model 2 Using STDTA ................................................ 35 vi ABBREVIATIONS HOSE Hochiminh Stock Exchange GROWTH Growth opportunities LTDTA Long-term debt to total assets PE Price-to-Earnings Ratio PROF Profitability ROA Return on assets ROE Return on equity ROI Return on investment SIZE Firm Size STDTA Short-term debt to total assets TA Asset tangibility TDTE Total debt to total equity TDTA Total debt to total assets TOBIN Tobin’s Q vii Capital Structure and Firm Performance CHAPTER 1: INTRODUCTION 1.1 BACKGROUND The theory of the capital structure is an important reference theory in firm's financing policy. The capital structure refers to firm includes mixture of debt and equity financing. The topic of optimal capital structure has been the subject of many studies. The modern theory of the capital structure originate from the contribution of Modigliani and Miller in 1958, under the perfect capital market assumption 1 that if there is no bankrupt cost and capital markets are frictionless, if without taxes, the firm value is independent with the structure of the capital. In 1963, under considering the corporate taxes, Modigliani and Miller modified the conclusion to recognize tax shield. Because debt can reduce the tax to pay, so the best capital structure of enterprises should be 100% of the debt. But this seems to be unreasonable in the real world. Jensen and Meckling (1976) introduce the concept of agency costs and investigate the nature of the agency costs generated by the existence of debt and outside equity. When considering corporation tax, bankrupt costs and agency costs at the same time, trade-off theory can be introduced to derive the existence of the optimum capital structure. Leland (1994) extends the results of Merton (1974) and Black and Cox (1976) to include taxes, bankruptcy costs to derive the optimal capital structure. Deangelo and Masulis (1980) argue that the existence of non-debt corporate tax shields such as depreciation deductions is sufficient to overturn the leverages irrelevancy theorem. Hovakimian, Opler, and Titman (2001) test the hypothesis that firms tend to a target ratio when they either raise new capital or retire or repurchase existing capital. They found firms should use relatively more debt to finance assets in place and relatively more equity to finance growth opportunities. It has also been argued that profitable firms are less likely to depend on debt in their capital structure than less profitable ones. It has been argued that firms with a high growth rate have a high debt to equity ratio. Bankruptcy costs (proxied by firm size) are also found to be an important effect on capital structure (Kraus and 1 Perfect capital markets means that the following assumptions hold: (a) there are no taxes, (b) there are no transaction costs, (c) there is symmetrical information, (d) there are homogenous expectations, and (e) investors can borrow at the same rate as corporations. Page 1 Capital Structure and Firm Performance Litzenberger, 1973; Harris and Raviv, 1991). If these three factors are considered as determinants of capital structure, then these factors could be used to determine the firm performance. In practice, firm managers who are able to identify the optimal capital structure are rewarded by minimizing a firm’s cost of finance thereby maximizing the firm revenue. If a firm capital structure influences a firm performance, then it is reasonable to expect that the firm capital structure would affect the firm health and its likelihood of default. From a creditor’s point view, it is possible that the debt to equity ratio aids in understanding banks’ risk management strategies and how banks determine the likelihood of default associated with financially distressed firms. In short, the issue regarding the capital structure and firm performance are important for both academics and practitioners. There is lack of empirical evidence about the effect of firm performance on capital structure in Vietnam. Then, the first objective of this study is to examine the effect which firm performance has on capital structure of listed companies in Hochiminh Stock Exchange. Trần Hùng Sơn and Trần Viết Hoàng (2008) find a positive and significant impact of firm leverage on firm accounting performance, but have not used market performance measures. Thus, the second objective of this study is to examine the effect which firm capital structure has on corporate market performance. This study contributes to literature in two directions: (1) by using ordinary least square regression model to investigate the relationship between capital structure and firm performance to fill the gap in corporate finance literature in Vietnam; (2) by employing different measures of capital structure such as short-term debt to total assets, long-term debt to total assets, total debt to total assets, and total debt to total equity to investigate the effect of the debt structure on corporate market performance in Vietnam. This study contributes to practical implications by investigating the effect of capital structure on corporate performance using market measures to provides evidence about whether the stock market is efficient or not. It also provides managers a structure approached to plan their firm capital structure strategies and improve the firm value. Page 2 Capital Structure and Firm Performance 1.2 RESEARCH PROBLEMS Problem definition is essential before conducting a study, especially quantitative research. Zikmund (1997, p. 82) recommends that formal quantitative research should not begin until the problem has been clearly defined. In Vietnam, lack of empirical evidence, that investigate the relationship between firm capital structure and firm performance, is an issue for both academics and practitioners. There is lack of empirical evidence that investigate the relationship between firm capital structure and firm performance in Vietnam. In 2008, Trần Hùng Sơn and Trần Viết Hoàng tested the relationship between capital structure and firm performance by using data sample of 50 non-financial companies in Hochiminh Stock Exchange for the period September 2008. The results show that there is a positive correlation between a firm capital structure and performance, which is measured by average of return on assets and return on equity. The corporate performance has a strong quadratic or cubic correlation with the capital structure when they use the debt ratio under 100%. The performance has a positive correlation with the capital structure when the debt ratio is in the range from 0.9755 to 2.799. However, they have not used market performance measures and have not explored the optimal capital structure to maximize the performance of the firm. They have not tested the correlation between the distribution of debt ratio and corporate performance to each type of companies, as well as each industry. Their research recommended that further research should be implemented. Margaritis and Psillaki (2007) use a sample of 12,240 firms from the 2004 New Zealand Annual Enterprise Survey to investigate the effect of leverage on firm performance as well as the reverse causality relationship. They use quantitative regression analysis to show that the effect of efficiency on leverage is positive at low to mid-leverage levels and negative at high leverage ratios. In Vietnam, there is no empirical evidence related to the effect of firm performance on capital structure. Therefore, the problem to be addressed in this study is to examine the effect of firm performance on firm capital structure combined with others variables such as firm size, growth and asset tangibility on firm capital structure. In addition, the author will explore the effect of firm capital structure on firm market performance, known as firm value of listed firms in Hochiminh Stock Exchange. Page 3 Capital Structure and Firm Performance 1.3 RESEARCH OBJECTIVES A research objective is the researcher’s version of a business problem. Objectives explain the purpose of the research in measurable terms and define standards of what the research should accomplish (Zikmund 1997, p. 89). In solving the research problem mentioned previously, this study has the following objectives: • Determine the effect of firm profitability, size, growth opportunities and asset tangibility on listed firm capital structure in Hochiminh Stock Exchange. • Determine the effect of capital structure on listed firm market performance combined with others variables such as firm size and growth opportunities in Hochiminh Stock Exchange. Research Questions Research questions involve the research translation of “problem” into the need for inquiry. The research problems defined above leads to the following research questions: • What are the relationship between firm capital structure and firm profitability, size, growth opportunities and asset tangibility of listed firms in Hochiminh Stock Exchange? • What are the relationship between firm capital structure, size, growth opportunities and firm market performance of listed firms in Hochiminh Stock Exchange? Two research variables of the topic: • Capital structure • Firm performance Page 4 Capital Structure and Firm Performance 1.4 RESEARCH METHODOLOGY AND SCOPE The object of this research is all listed non-financial companies in Hochiminh Stock Exchange (HOSE) at the end 2008. Sample size: 162 (See more in Chapter 3). Quantitative research based on ordinary least square regression model to estimate the relationship between firm profitability, size, growth, asset tangibility and firm capital structure, as well as the relationship between firm leverage and firm market firm performance. This model was used in the previous studies of Tian & Zeitun (2007), Margaritis & Psillaki (2007), Rajan and Zingales (1995). The author use data analysis tools to implement the research such as: descriptive statistics, multiple regression models with Eviews 6 for Windows. 1.5 STRUCTURE OF THE STUDY The structure of the study consist five chapters: Chapter 1: Introduction This chapter presents research background of the study, as well as, research problems, research objectives, research methodology and scope. Chapter 2: Literature Review In this chapter, I summary the literature review and present the fundamental ideas on capital structure, as well as firm performance. This chapter also presents a research model of the study. Chapter 3: Research Design Based on the research objectives and scope, research methodology concerned in chapter 1, and literature review and empirical model presented in chapter 2, this chapter particularly presents the research methodology, data, research design and research process. Chapter 4: Empirical Results of the Research Chapter 4 presents the characteristics of research samples and measures concepts of the research. I use descriptive statistics to explore the features of explanatory variables, as well as the relationship between each variable in two models. Page 5 Capital Structure and Firm Performance Furthermore, I use regression analysis to explore the relationship between the capital structure and market performance of listed companies in Hochiminh Stock Exchange. Chapter 5: Conclusions, Recommendations and Limitations Chapter 5 presents main conclusions and recommendations based on the results of the previous chapters, as well as the limitations of this study. Page 6 Capital Structure and Firm Performance CHAPTER 2: LITERATURE REVIEW 2.1 INTRODUCTION Chapter 2 summaries the literature review and present the fundamental ideas on capital structure, as well as firm performance. This chapter also presents a research model of the study. 2.2 CAPITAL STRUCTURE The modern theory of capital structure began with the celebrated paper of Modigliani and Miller (1958). In this paper they claim that under perfect capital market conditions, a firm value depends on its operating profitability rather than its capital structure. In 1963, Modigliani and Miller argued that, when there are corporate taxes then interest payments are tax deductible, 100% debt financing is optimal. In this framework, firms target an optimal capital structure based on tax advantages and financial distress disadvantages. Firms are thought to strive toward their target and can signal their future prospects by changing their structure. Adding more debt increases firm value through the market’s perception of higher tax shields or lower bankruptcy costs. But optimal capital structure at a 100% debt financing are clearly incompatible with observed capital structures, so their findings initiated a considerable research effort to identify costs of debt financing that would offset the corporate tax advantage. Since bankruptcy costs exist, deteriorating returns occur with further use of debt in order to get the benefits of tax deduction. Therefore, there is an appropriate capital structure beyond which increases in bankruptcy costs are higher than the marginal tax-sheltering benefits associated with the additional substitution of debt for equity. Firms are willing to maximize their performance, and minimize their financing cost, by maintaining the appropriate capital structure or the optimal capital structure. Harris and Raviv (1991) argue that capital structure is related to the trade-off between costs of liquidation and the gain from liquidation to both shareholders and managers. So firms may have more debt in their capital structure than is suitable as it gains benefits for both shareholders and managers. Since then, extensions of the Modigliani and Miller theory have been provided by the following researches. Robichek and Myers (1966) argue that the negative effect Page 7 Capital Structure and Firm Performance of bankruptcy costs on debt to prevent firms from having the desire to obtain more debt. Jensen and Meckling (1976) emphasize the importance of the agency costs of equity in corporate finance arising from the separation of ownership and control of firms whereby managers tend to maximize their own utility rather than the value of the firms. The general result of these extensions is that the combination of leverage related costs (such as bankruptcy and agency costs) and a tax advantage of debt produces an optimal capital structure at less than a 100% debt financing, as the tax advantage is traded off against the likelihood of incurring the costs. This leads us to Jensen’s (1986) “free cash flow theory” where as stated by Jensen (1986, p. 323) “the problem is how to motivate managers to disgorge the cash rather than investing it below the cost of capital or wasting it on organizational inefficiencies”. In other words complete contracts cannot be written. A higher level of leverage may be used as a disciplinary device to reduce managerial cash flow waste through the threat of liquidation (Grossman and Hart, 1982) or through pressure to generate cash flows to service debt (Jensen, 1986). Titman (1984) demonstrates an idea of indirect bankruptcy costs. He argues that stakeholders did not represent at the bankruptcy bargaining table, such as customers, could suffer material costs resulting from the bankruptcy. Leland (1994) demonstrates a standard trade-off model. At the optimal capital structure, marginal bankruptcy costs associated with firm’s debt are equated with marginal tax benefits. The static tradeoff theory is the original retort to the theory of capital structure relevance. However, as stated in the previous literature, underestimating the bankruptcy costs of liquidation or reorganization, or the aligned interest of both managers and shareholders may lead firms to have more debt in their capital structure than they should (see, for example, Harris and Raviv, 1991). Krishnan and Moyer, (1997) find a negative and significant impact of total debt to total equity (TD/TE) on return on equity (ROE). Another study by Gleason, Mathur and Mathur, (2000) find that firm capital structure has a negative and significant impact on firm performance measures return on assets (ROA), growth in sales (Gsales), and pretax income (Ptax). Therefore, high levels of debt in the capital structure would decrease the firm performance. However, not only does a firm’s level of leverage affect corporate performance and failure but also its debt maturity structure (Barclay and Smith, 1995 and Ozkan, 2002). Schiantarelli and Sembenelli (1999) investigate the effects of firm’s debt maturity structure on profitability for Italy and the United Kingdom. They find a positive relationship between initial debt maturity and medium term performance. Page 8 Capital Structure and Firm Performance A study by Barclay and Smith (1995) provide evidence that large firms and firms with low growth rates prefer to issue long-term debt. Another study by Stohs and Mauer (1996) suggest that larger and less risky firms usually make greater use of long-term debt. They also find that debt maturity is negatively related to corporate tax, the firm’s risk and earnings surprises. In other words, the choice of debt structure could have an impact on both corporate performance and failure risk. Furthermore, there are other factors, besides capital structure, that may influence firm performance such as firm size, age, growth, risk, tax rate, factors specific to the sector of economic activity, and factors specific to macroeconomic environment of the country. Dilip Ratha, et al (2003) studies the relationship between corporate performance (as measured by its profit rate or earnings before interest and taxes) and corporate finance (debt/assets ratio) in developing countries. First, they find out that both profits and earnings before interest, taxes, depreciation, and amortization decline as a percentage of assets as firms take on more debt relative to their assets. This is similar to the finding of Harvey, Lins, and Roper (2001) that; while some debt may improve market discipline in firms, the effect may be overcome by increasing financial risks. Second, the marginal (negative) effect of an increase in leverage on earnings is larger for firms that participate in international debt markets than for other firms. However, they have not used market performance measures to study the relationship of corporate finance and corporate performance. Wei Xu, et al (2005) analyzes the relationship between corporation performance and capital structure of 1,130 listed companies in China. The results show that the firm’s performance has a strong negative correlation with the capital structure. It does not agree with the western empirical result for the higher debt ratio. The corporation performance has a strong quadratic or cubic correlation with the capital structure when they use the debt ratio under 100%. The performance has a positive correlation with the capital structure when the debt ratio is in the range from 24.52% to 51.13%. Allan N. Berger, et al (2006) uses a new approach to test agency theory in US banking industry and the findings are consistent with the agency costs hypothesis higher leverage or a lower equity capital ratio is associated with higher profit efficiency over almost the entire range of the observed data. And the results are statistically significant, economically significant, and robust. Margaritis and Psillaki (2007) use a sample of 12,240 firms from the 2004 New Zealand Annual Enterprise Survey to investigate the relationship between firm Page 9 Capital Structure and Firm Performance efficiency and leverage as well as the reverse causality relationship. They find evidence supporting the theoretical predictions of the Jensen and Meckling (1976) agency cost model. More precisely, they find support for the core prediction of the agency cost hypothesis in that higher leverage is associated with improved efficiency over the entire range of observed data. They use quantitative regression analysis to show that the effect of efficiency on leverage is positive at low to midleverage levels and negative at high leverage ratios. Thus their results suggest that in the upper range of the leverage distribution the income effect resulting from the economic rents generated by high efficiency dominates the substitution effect of debt for equity capital. They also show that the more efficient firms will choose higher debt ratios because higher efficiency acts as a buffer against the expected costs of bankruptcy or financial distress. The effect of tangibles and profitability on leverage is positive. Firm size has a negative effect on leverage at the lower half of the leverage distribution and a positive effect at the upper half of the distribution. The effect of intangibles and other assets is estimated to be negative. Tian & Zeitun (2007) examine the impact which capital structure has had on corporate performance in Jordan in which they controlled the effect of industrial sectors, regional risk, such as the Gulf Crisis 1990-1991 and the outbreak of Intifadah in the West Bank in September 2000. They have used a cross-sectional data representing of 167 Jordanian companies during 1989-2003. The results show that a firm capital structure has a significantly negative impact on the firm performance measures, in both the accounting and market measures. An interesting finding is that the short-term debt to total assets level has a significantly positive effect on the market performance measure (Tobin’s Q), which could to some extent support Myers (1977) argument that firms with high short-term debt to total assets have a high growth rate and high performance. Firm size is found to have a positive impact on a firm performance, as large firms have low bankruptcy costs. The insignificance of the market performance measure PE indicates that the Jordanian equity market is not efficient, so the best performance measure is the accounting performance measure ROA. In Vietnam, Trần Hùng Sơn and Trần Viết Hoàng (2008) test the relationship between firm capital structure and performance by using data sample of 50 nonfinancial companies in Hochiminh Stock Exchange for the period September 2008. The results show that there is a positive correlation between a firm capital structure and performance. The corporation performance has a strong quadratic or cubic correlation with the capital structure when they use the debt ratio under 100%. The performance has a positive correlation with the capital structure when the debt ratio is in the range from 0.9755 to 2.799. State owned ratio has negative impact on firm Page 10 Capital Structure and Firm Performance efficiency, but firm growth, size (measured by logarithm of the firm’s assets) and tangibility had no significant impact on firm performance. However, they have not used market performance measures and did not explore the optimal capital structure to maximize the performance of the firm. They have not test the correlation between the distribution of debt ratio and corporate performance to each type of companies, as well as each industry. 2.3 FIRM PERFORMANCE The concept of performance is a controversial issue in finance largely due to its multidimensional meanings. Research on firm performance emanates from organization theory and strategic management (Murphy et al., 1996). Performance measures are either financial or organizational. Financial performance such as profit maximization, maximizing profit on assets, and maximizing shareholders' benefits are at the core of the firm effectiveness (Chakravarthy, 1986). Operational performance measures, such as growth in sales and growth in market share, provide a broad definition of performance as they focus on the factors that ultimately lead to financial performance (Hoffer and Sandberg, 1987). The usefulness of a measure of performance may be affected by the objective of a firm that could affect its choice of performance measure and the development of the stock and capital market. For example, if the stock market is not highly developed and active then the market performance measures will not provide a good result. The most commonly used performance measure proxies are return on assets (ROA) and return on equity (ROE) or return on investment (ROI). These accounting measures representing the financial ratios from balance sheet and income statements have been used by many researchers (e.g., Demsetz and Lehn, 1985; Gorton and Rosen, 1995; Mehran, 1995; and Ang, Cole and Lin, 2000). However, there are other measures of performance called market performance measures, such as price per share to the earnings per share (PE) (Abdel Shahid, 2003), market value of equity to book value of equity (MBVR), and Tobin’s Q. Tobin’s Q mixes market value with accounting value and is used to measure the firm's value in many studies (e.g., Morck, Shleifer, and Vishny, 1988; McConnel and Serveas, 1990; and Zhou, 2001). The performance measure ROA is widely regarded as the most useful measure to test firm performance (Reese and Cool, 1978; Long and Ravenscraft, 1984; Abdel Shahid, 2003, among others). The stock Page 11
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