MINISTRY OF EDUCATION & TRAINING
UNIVERSITY OF ECONOMICS HO CHI MINH CITY
------------
MAI THI PHUONG THAO
DETERMINANTS OF CAPITAL
STRUCTURE: AN EMPERICAL
RESEARCH OF LISTED COMPANIES IN
HOSE
MASTER THESIS OF BUSINESS ADMINISTRATOR
HO CHI MINH CITY – 2013
MINISTRY OF EDUCATION & TRAINING
UNIVERSITY OF ECONOMICS HO CHI MINH CITY
------------
MAI THI PHUONG THAO
DETERMINANTS OF CAPITAL
STRUCTURE: AN EMPERICAL
RESEARCH IN HOSE LISTED
COMPANIES
Subject: Master of Business Administrator
Code: 60.34.01.02
THESIS OF MASTER OF BUSINESS ADMINISTRATOR
SUPERVISOR:
DR. VO XUAN VINH
HO CHI MINH CITY – 2013
I
ABSTRACT
This paper attempts to investigate the determinants of the capital structure of a
sample of listed companies on the Ho Chi Minh Stock Exchange from 2007 to
2012. After refining the data, this study can be able to use 271 companies to
make the investigation on the determinants of the capital structure by
observation in all samples, in each year and in each business sectors. The
relationship between PE, EPS, tangibility, profitability, size, and liquidity to
the leverage (including total debt and short-term debt ratio) are gradually
shown up. The findings reveal that PE, tangibility, profitability, size and
liquidity are highly significant. However, EPS are not much effect to leverage.
The results confirm that in each economics status, the components of capital
structure have their tendency toward the gearing.
Finally, the business factors also affect to the determinants of leverage will
emphasis the difference in decision of capital structure in each industry.
II
ACKNOWLEDGEMENT
I would like to express my gratitude to all those who gave me the
possibility to complete this thesis.
I want to thanks all my lecturers in course at University of Economics
Ho Chi Minh City, who have empowered me with considerably useful
knowledge during the time I studied, especially Dr. Vo Xuan Vinh, who
support in this thesis, thanks for his patience, motivation, enthusiasm, and
immense knowledge to judge and comment on the contents of the subject.
Besides my advisor, I would like to thank the rest of my friend in
eMBA class, for kindly helping me during my study and thesis processing.
Last but not the least; I would like to thank my family for supporting
me spiritually throughout my life.
Although I has tried the best to complete the thesis, but errors could not
be comprehensively avoided. Therefore, I am also looking forward to
receiving the inputs and comments from respectful lecturers and friends, so
that the thesis could be extended and improved.
Mai Thi Phuong Thao
Ho Chi Minh, November 2013
III
COMMITMENT
I would like to commit that this thesis, “DETERMINANTS OF
CAPITAL STRUCTURE: A EMPERICAL RESEARCH OF LISTED
COMPANIES IN HOSE”, was accomplished based on my individual study
and research. The data was collected based on the secure sources.
Mai Thi Phuong Thao
1
Table of Contents
TABLE OF CONTENTS ......................................................................................................... 1
CHAPTER 1 INTRODUCTION .......................................................................................... 4
1.1
Background .................................................................................................................... 4
1.2
Problem Statement ........................................................................................................ 5
1.3
Purpose of Research ...................................................................................................... 7
1.4
Organisation of the Study ............................................................................................. 7
CHAPTER 2 LITERATURE REVIEW AND HYPOTHESIS ......................................... 8
2.1
Definition: ....................................................................................................................... 8
2.2
Theories........................................................................................................................... 8
2.2.1.
Modigliani and Miller............................................................................................. 10
2.2.2.
Trade-off theory and Pecking order theory ............................................................ 13
2.2.3.
Agency cost models ................................................................................................ 17
2.2.4.
Other models .......................................................................................................... 19
2.3
Empirical study on Capital Structure in Vietnam.................................................... 24
CHAPTER 3 METHODOLOGY ....................................................................................... 26
3.1
Data Collection ............................................................................................................. 27
3.2
Developing Hypotheses ................................................................................................ 27
3.2.1.
Dependent Variables .............................................................................................. 28
3.2.2.
Independent Variables: ........................................................................................... 30
3.2.3.
Hypotheses: ............................................................................................................ 30
a.
PE and EPS: .................................................................................................................. 30
2
b.
Tangibility (TANG) ........................................................................................................ 31
c.
Profitability (PROFIT) .................................................................................................. 32
d.
Firm Size (SIZE) ............................................................................................................ 33
e.
Liquidity (LIQD) ............................................................................................................ 35
3.3
Methods of Analysis ..................................................................................................... 37
3.3.1.
Descriptive analysis ................................................................................................ 38
3.3.2.
Pearson correlation ................................................................................................. 38
3.3.3.
Multiple regression analysis ................................................................................... 38
CHAPTER 4 DATA ANALYSIS AND FINDING ............................................................ 41
4.1
Descriptive statistic ...................................................................................................... 41
4.2
Correlations between Variables ................................................................................. 44
4.3
Multiple Regression Analysis ...................................................................................... 45
4.4
Testing on Regression Result ...................................................................................... 48
4.5
Conclusion .................................................................................................................... 49
4.5.1.
EPS with leverage................................................................................................... 50
4.5.2.
PE with leverage ..................................................................................................... 51
4.5.3.
Tangibility to leverage ............................................................................................ 52
4.5.4.
Profit to leverage .................................................................................................... 53
4.5.5.
Size to leverage....................................................................................................... 54
4.5.6.
Liquidity to leverage............................................................................................... 56
4.5.7.
Determinants of capital structure from 2007 to 2012 ............................................. 57
4.5.8.
Determinants of capital structure in observing in business sectors ........................ 59
CHAPTER 5 IMPLICATION ............................................................................................ 61
3
5.1
Summary of finding and discussion ........................................................................... 61
5.2
Limitation of thesis ...................................................................................................... 64
5.3
Recommendation for future study ............................................................................. 64
REFERENCES........................................................................................................................ 66
4
CHAPTER 1
1.1
INTRODUCTION
Background
Capital structure decisions have been agued amongst theorists and practitioners in
finance for many years. The underlying question of such research is how and why
companies come to the debt-equity ratios in their decision for capital structures and
which determinants would affect their decision.
There are varying ways to define the debt ratio. Some of companies prefer self
financing while the others want to utilize the leverage. To see how much a company
relies on debt financing, the comparison between two companies is the good example:
the cash-rich Microsoft (MSFT), and the hugely leveraged Amazon (AMZN).
Microsoft, in 2000, claimed earnings before interest, taxes, depreciation and
amortization, or EBITDA, of $11.8 billion, had a negative cash flow of $340.7 million
in the same year. That very low ratio reflects that Microsoft has zero long-term debt,
and its short-term debts are relative to its massive assets. In comparison with ultrasolvent Microsoft, Amazon looks positively deficit. The extremely high debt ratio
(2,723.6 divided by 1,852, or 1,470.2) reflects that its total debts significantly outstrip
its total assets. (Swanson, 2001)
This example could show that there are differences of the decision in defining the
appropriate capital structure. The reason could be based on the difference in business
activity or some determinants could affect to the debt ratio.
For a long time it has been believed that an optimal debt-equity choice exists for any
firm, and that this optimal capital structure is a tradeoff between the advantages of debt
financing and the disadvantages of bankruptcy risks. From a firm’s perspective, debt is
5
often a cheaper source of finance than equity because of tax advantages to be gained.
Debt is preferred over equity, especially where the firm does not face financial distress.
Since the publication of Modigliani and Miller’s (1958; 1963) seminal article, this
argument had been developed by many theories try to explain variation in debt ratio
across the firm. Until now, the analysts don’t argue about which theories are the best
use for company but they start to find which factor that will affect to the financial
decision and performance of the company.
1.2
Problem Statement
Modigliani and Miller (1958) stated their famous irrelevance theory, where under
perfect conditions, the choice of debt or equity is irrelevant. When other research
irrelevant, such as Myers and Majluf (1984) run the test, which is result of agency cost,
as the underlying theory of how a firm comes to decide the debt-equity distribution.
Many other theories have been proposed and tested, but the Tradeoff Theory, including
agency costs as part of the tradeoff, is still often applied and discussed in literature.
It seems that no perfect theory exists, and many theories explain only a part of the
story. Perhaps one theory cannot be sufficient for one firm’s capital structure
determination (S.C. Myers, 2001).
In many years later, through the empirical work among the world and each country,
financial economics has yet to provide agreement about which factors affect the
selection of a specific leverage position. The empirical evidence on capital structure in
developed countries found that the choice of debt-equity ratio can be modeled subject
to the agency cost (Marsh, 1982; Titman & Wessels, 1988). With the similar method,
data from industrialized countries help explaining the differences in firms’ capital
structure (Rajan & Zingales, 1995).
6
In the next decade, those studies approach to UK firms and interestingly, those
empirical studies indicate that the determinant of capital structure are the size, asset
structure, growth opportunities, profitability and non-debt tax shields (Bennett &
Donnelly, 1993; Lasfer, 1995; Ozkan, 2001). However, other studies suggest that
highly leveraged firms are likely to borrow more because they can afford the debt
(Castanias, 1983; DeAngelo & Masulis, 1980; Gilson, 1997; Peyer & Shivdasani,
2001) . In such cases, the firm specific factors may exert a different impact on the
capital structure choice of firms depending on their level of leverage.
Finally, not all determinants are consistent with those predictions advanced by theories
of finance. Indeed, there are some contrary results on the relationship between some
determinants and capital structure among firms in some countries (Heshmati, 1997).
In Vietnam, the decision for debt ratio is recently a critical question to all companies.
After affecting from economics recession in 2007, Vietnamese corporation began to
worry about decision of financing for their own company. This will lead to one of the
most important factor on managing the risk of company.
Many studies explain the different way to construct the debt ratio but it also show that
there are some determinants have the strong relationship with capital structure.
However, very few of empirical researches could perform in each industry that can
prove the significant influences to capital structure. The research of (T. D. K. Nguyen
& Ramachandran, 2006) show the proof in comparing the financing policies between
state-owned companies and private corporation which are very different (Biger, N., &
Hoang, 2007).
7
1.3
Purpose of Research:
My research, aims at contributing to the discussion on capital structure’s decision by
examining the influence of specific determinants. Besides, adding more confirmation
on the explanation that each industry will have the similar capital structure and the
different capital decision’s decision to each economics sectors.
The observation data run through period from 2007 to 2012 with many status of
economics circle to find the significant factors of capital structure or debt ratio. The
data is taken from financial statement of list companies in Ho Chi Minh Stock
Exchange (HOSE).
Then the research also requires separating into each business to examine the influence
of specific determinants in their own industry including economics period which affect
to company’s debt ratio. This study has combined data from financial statements of
listed companies to examine the determinants as earning per share, price to EPS ratio,
tangibility ratio, profitability, size, and liquidity.
The panel regression model is used as the technique to determine statistical significance
of the variables. The sample comprises of 271 public listed companies on the
Hochiminh Stock Exchange (HOSE) for the period from 2007 to 2012. Along with
database and methodologies, the result could support the hypothesis and reconfirm the
finding on the previous theories subject to the data of listed companies in HOSE.
1.4
Organisation of the Study:
The next section explores the range of theoretical determinants of capital structure
along with a summary of the findings of the previous influential empirical studies.
Section 3 put forwards the research methodology of the study, provides a description of
the data set, and discusses the variables formulated and tested and the limitations
inherent in the research methodology. The fourth chapter presents the results and
analysis of the regression models and concludes the dissertation.
8
CHAPTER 2
2.1
LITERATURE REVIEW AND HYPOTHESIS
Definition:
Capital structure is how a firm finances its overall operations and growth by using
different sources of funds. There are many ways to finance its assets by combination of
equity, debt, or hybrid securities. A firm's capital structure is then the composition or
structure of its liabilities.
In order to measure the capital structure, we use the leverage ratio to see how each
company react with their capital. In finance, we define three ratios related to debt: total
debt ratio, long-term debt ratio and short-term debt ratio.
Total debt to total assets is a leverage ratio that defines the total amount of debt relative
to assets. This enables comparisons of leverage to be made across different companies.
This is a broad ratio that includes long-term and short-term debt (borrowings maturing
within one year), as well as all assets – tangible and intangible.
However, in this research, we only use two debt ratios as the dependent variables for
my model: total debt ratio and short-term debt ratio.
There are some determinants that affect the capital structure. In the next part, we will
define those determinants by reviewing the majorities of theories in related.
2.2
Theories
A review of empirical evidence reveals a number of relevant theories for my study.
Modigliani and Miller (1958) paper was found as the early literature which addressed
to capital structure. The finance literature on capital structure has continued to develop
after that. Most of well-known researches broadly classified in following types: Static
trade-off theory, pecking order theory, agency cost theory and others models. The main
9
purpose of this chapter is to examine the available theories and to discuss their
significance in the quest to offer a solution to the capital structure debate. Moreover,
the chapter also discusses the results of influential studies to provide empirical
evidences that have been gained so far by the researchers.
Before moving into the detail of these theories the following table will illustrate the
basic concepts behind the existing theories.
Table 2.1: Propositions of the theory with regard to capital structure Decisions
Theory
Content
The value of the firm is determined by the left-hand side of the
balance sheet that is by real assets and they remain unaffected
Modigliani and
Miller (1958)
whether the liability side of the firm’s balance sheet is sliced into
more or less debt. Therefore, to increase the value of the firm,
investment should be done in positive net present value projects.
(Brealey, Myers, & Allen, 2006)
A firm borrows to the point where the marginal value of tax
Trade-off Theory
shield on additional debt just offset the increase in the present
value of costs of financial distress. (S.C. Myers, 2001)
Pecking Order
Theory
The theory states that firms prefer internal finance. If external
financing is required firm first opt for safest security that is debt
and equity is raised as a last resort. (S.C. Myers, 1984)
According to the theory, raising debt has the potential to reduce
Agency Cost Model
agency problems. (M. S. Jensen, 1986)
10
Market of Corporate
Control
The choice of optimal debt level is based on trading off a decrease
in profitability of acquisition against an increase in the share of
the expected gain for target’s shareholders. (Israel, 1991)
A firm which will ignore the importance of financial structure will
face a lower value than a firm which realizes the importance of
financial decisions. The model suggests that the structure of credit
Product/Input Model
market may impact the economic performance of output markets
and also that the advantage of using debt that is interest
deductibility may lead to higher debt levels. (Israel, 1991)
2.2.1.
Modigliani and Miller
Capital structure is defined as the relative amount of debt and equity used to finance a
firm. Theories explaining capital structure and the variation of debt ratios across firms
range from the irrelevance of capital structure, proposed by Modigliani and Miller
(1958).
“If leverage can increase a firm's value in the MM tax model (F. Modigliani & Miller,
1963), firms have to trade off between the costs of financial distress, agency costs (M.
C. Jensen & Meckling, 1976) and tax benefits, so as to have an optimal capital
structure. However, asymmetric information and the pecking order theory (S.C. Myers,
1984; S.C. Myers & Majluf, 1984) state that there is no well defined target debt ratio.
The latter model suggests that there tends to be a hierarchy in firms' preferences for
financing: first using internally available funds, followed by debt, and finally external
equity.”
11
These theories identify a large number of attributes influencing a firm's capital
structure. Although the theories have not considered firm size, this section will attempt
to apply the theories of capital structure in the small business sector, and develop
testable hypotheses that examine the determinants of capital structure in Vietnamese
firms.
In almost every paper relating to capital structure, the framework produced by
Modigliani and Miller is discussed first as they are known for the most acknowledged,
criticized or most researched paper. Given the differences in the opinion by the
academic world in accepting or challenging the propositions of these two economists,
the fact remains that their ‘The cost of capital, corporation finance and the theory of
investment’ gave birth to the most important debate in the corporate finance literature
which further produced huge amount of theoretical and empirical research.
As in every model, Modigliani and Miller (1958) framework was also operational
under certain assumptions. The basic assumption was of perfect capital markets and
zero transaction costs and tax. They further assumed that individuals and corporations
borrow at the risk free rate, firms issue only two types of claims; risk free debt and
risky equity, there is neutral or no enterprise or individual income tax, no bankruptcy
costs are associated with raising debt, investors have same homogenous expectation for
the payoff and rate of risk, all firms belong to the same risk class, all cash flows are
perpetuities with constant growth and assumed a world without information costs and
agency costs. (Berry, 2006)
According to this proposition financial leverage that is the amount of debt in the capital
structure of the firm is irrelevant. Moreover, financial leverage remains irrelevant even
when the debt maturity is short term, long term or the debt is callable or call protected,
straight or convertible or in any denomination (S.C. Myers, 2001). It is also important
12
to identify the factors that can change the value of the firm when there are changes in
growth opportunities. First of all, when there are sudden changes in the growth of the
firm, the working capital will also reflect these changes and so will the liquidity ratio,
debt service ratio, fixed assets of the firm and which will drive the value of the firm.
According to their second proposition the expected rate of return on the common stock
of a levered firm increases in proportion to the debt (D) to equity (E) ratio (from figure
2.1 that is market values). Moreover, the rate of increase depends on the spread
between the expected rate of return on a portfolio of all securities and the expected
return on the debt. Thus, in view of this proposition the rate of return the shareholders’
receives depends on the firm’s debt to equity ratio. (Brealey, et al., 2006)
To sum up Modigliani and Miller (1958) proposed that the value of the firm is
determined by the left-hand side of the balance sheet that its real assets and they remain
unaffected whether the liability side of the firm’s balance sheet is sliced into more or
less debt. Therefore, to increase the value of the firm investment should be done in
projects with positive net-present values (Brealey, et al., 2006).
Modigliani and Miller (1958) propositions were based on strict assumptions which
further produced results which were highly criticized by the researchers and in
academics. According to Brealey, Myers and Allen (2006), Modigliani and Miller
opponents argue that market imperfections makes personal borrowing excessively
costly and risky which creates a natural clientele willing to pay a premium for shares of
leveraged firms. Thus, the opponents argue that firms have to borrow to realize the
premium. Secondly, Brealey, Myers and Allen (2006) also points out that according to
the two American economists the overall cost of capital of a firm known as weighted
average cost of capital (WACC) does not depend on the capital structure which further
raises questions with the introduction of taxes. When we introduce taxes, it is also
13
important to note that debt interest is tax-deductible, and WACC is also computed on
after tax interest rate. Thus, given the tax advantage on debt, a firm may be inclined to
use more debt in capital structure.
2.2.2.
Trade-off theory and Pecking order theory
Pecking order theory suggests that a firm's growth is negatively related to its capital
structure. According to Myers and Majluf (1984), information asymmetry demands an
extra premium for firms to raise external funds, irrespective of the true quality of their
investment project. In the case of issuing debt, the extra premium is reflected in the
higher required yield. High-growth firms may find it too costly to rely on debt to
finance growth.
Trade-off Theory
The second important theory in corporate finance literature is the trade-off theory,
According to the theory; a firm borrows to the point where the marginal value of tax
shields on additional debt just offset the increase in the present value of costs of
financial distress (S.C. Myers, 2001). Before moving forward with the definition, at
this point some elaborations are important. Consider a company that utilizes debt in its
capital structure. By raising debt, the first advantage that the company makes is that of
interest payments which are treated as a tax deductible expense also known as the tax
shield. However, there is another side of debt which is that the firm is now exposed to
bankruptcy risk or financial distress. The reason being that if the company is unable to
generate cash from its operating, financing or investing activities to service its debt
obligations than the firm is likely to go bankrupt.
Modigliani and Miller (1958) points out that a company that heavily relies on debt in
the capital structure commits a company to pay out considerable portion of its income
14
in the form interest payments. However, a debt free company can reinvest all of its net
income in its business. The objective here is not to indulge in the debate of raising debt
or equity but to appreciate the relative advantages and associated disadvantages of
both. Moreover, it is also important to note that it is highly unlikely to find a firm
which relies only on one source of capital. However, the question still arises as to how
would a value maximizing firm constructs its capital structure in other words is there an
ideal debt to equity ratio? According to the trade-off theory a value maximizing firm
would compare benefit and cost at the margin and operate at the top of the curve in
Figure 2.1. The curve would top out at high debt ratios for safe, profitable firms with
taxes to shield and assets whose value will not deteriorate in financial distress.
Moreover, the theory also predicts reversion of the actual debt ratio towards a target or
optimum, and a cross-sectional relation between average debt ratios and asset risk,
profitability, tax status and asset type (Shyam-Sunder & Myers, 1999).
Figure 2.1: The Static-tradeoff Theory of Capital Structure. Source: Myers (1984)
15
One major cost associated with debt is the cost of financial distress which makes firm’s
reluctant to highly depend on debt as a source of finance. Figure 2.1 above shows that
at moderate debt levels the probability of financial distress is negligible but at later
point of time the probability of financial distress increases rapidly with additional
borrowings. Moreover, if the firm keeps on raising debt and is not sure of gaining from
the corporate tax shield, the advantage of tax eventually disappears as the firm is likely
to go bankrupt (Brealey, et al., 2006).
Modigliani and Miller (1958) model was built on the assumption of zero taxation.
Later, in order to capture the implication of corporate tax and its effect on cost of
capital Modigliani and Miller offered a new article to the corporate finance literature
‘Corporate Income Taxes and the Cost of Capital’. Thus, now they proposed that value
of firm becomes the value if all equity financed plus the present value of tax shield
minus the present value of costs of financial distress (Brealey, et al., 2006).
It is also important to note that the costs of financial distress may directly or indirectly
affect a firm. According to Ang, Chua, McConnell (1982), the literature identifies three
types of bankruptcy costs (1) the direct administrative costs paid to different third party
involvement in the bankruptcy proceedings, (2) the loss or shortfall when assets are
sold in liquidation or in the indirect costs of reorganization and (3) the loss of tax
credits when the firm is bankrupt.
Pecking Order Theory
The next competing theory in the corporate literature is pecking order theory of finance
which resulted from the study done by Donaldson (1961) and was later developed by
Myers and Majluf (1984). Donaldson (1961) in his paper observed that management
prefer internal funds as a source of new finance and were reluctant to issue common
stock. Based on the new set of result of the study that managers prefer internal source
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