Professional Documents
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Trade-Off Theory or Pecking Order Theory with a StateOwnership Structure: The Vietnam Case
Sbastien. Dereeper1 and Quoc Dat. Trinh2
The process firms use to choose their capital structures is explained
by different corporate finance theories in which trade-off and pecking
order are the two most popular hypotheses. Testing these two
models will help to determine whether a target debt ratio exists, and
if so, how rapidly firms adjust their current leverage levels to match
this target level. The findings in this paper determined that the
pecking order theory might not be applied in Vietnam when internal
funds and new equity issuance are independent with the leverage
level. In contrast, our empirical results proved that the long-run target
debt ratio does exist in the Vietnamese market. The partialadjustment model has shown that both private firms and state-owned
firms rapidly adjust to their optimal levels of debt. However, the state
ownership structure does not affect the amount of debt taken during
the year by the firms.
Field of Research: capital structure, state-owned firms, private firms, speed adjustment.
1. Introduction
Although being published in stock exchange is an efficient way to raise middle and longterm funds, firms still continue borrowing from financial intermediaries such as banks or
financial companies for many reasons. The conflicts among shareholders and managers of
the firms might be one of those reasons. When raising funds from the stock market, firms
managers need to report business activities to many other new shareholders. This means
they are loosening their control to the firms and they need to disclose more inside
information to public. This is not what managers want because Jensen and Meckling (1976),
with the concept of separation of ownership and control, indicated that managers can be
more interested in transferring firms resources into their personal benefits instead of
spending efforts on leading the firms. The decisions made by managers will not totally
maximize firms value as it would be. In contrast, although shareholders do not directly
control and manage firms activities, they do own the firm and receive a fraction of the gain.
Shareholders will need to pay some costs to the managers and establish appropriate
monitoring solutions with the hope that the managers will act for the best benefits of
shareholders.
However, raising funds from banking system also faces many difficulties. These might be
the costs of bankruptcy if firms are out of payment, or other accurate borrowing conditions
issued by the banks that firms must satisfy. Generally, banks approve firms loans based on
their own appraisal processes. However, in emerging market, where the effect of the state
on financial market is quite obviously, the decisions of banking system on how to give loans
to firms might be remarkably affected by the governments policy.
1
Dr. Sbastien. Dereeper, Professeur des Universits, Universit de Lille 2 - SKEMA Business school,
ECCCS research center, sebastien.dereeper@univ-lille2.fr;
2
Quoc Dat, Trinh, Universit de Lille 2 - SKEMA Business school, ECCCS research center,
quocdat.trinh@etu.univ-lille2.fr;
115
2. Literature Review
Since the study of Miller and Modigliani (MM) in June 1958, capital structure theory has
been continued studying properly. The trade-off theory, which rejects the irrelevance
preposition by considering imperfect and friction capital market, suggests that a firm should
maximize its value by balancing the costs and benefits of borrowing debts. While costs of
debts are majored as the financial bankrupt cost or distress cost when firms used
extravagant debts and might not be able to meet the deadline of interest and principal
payments, the most significant gain of debt is identified by the debt-tax shield through
interest deduction. The optimal debt level is considered as the intersection between
marginal costs and marginal benefits of using more debts (Myers, 1984). Therefore, static
trade-off theory recommends that a firm should substitute between equity and debt till it
reaches the target ratio to maximize its value. However, in a dynamic world, firm itself
changes overtime. The dynamic tradeoff theory states that optimal debt ratio of the firm is
adjusted by the change of exogenous and endogenous factors.
In contrast, the pecking order theory, which considers the asymmetric information
assumption, predicts that no optimal leverage level is preferred. In fact, firms prefer to use
internal funds to finance for their capital demand before borrowing debts or issuing stock.
The main assumption of the theory, asymmetric information, indicates the costs of adverse
selection. This predicts that firms owners (insiders) normally have more information of the
firms than investors (outsiders). Because of that, if firms issue equity to finance for new
projects, the market might consider those projects as ineffective or high risk projects.
Consequently, equity would be underpriced. New projects are going to be rejected even
they have positive NPV. Leland and Pyle (1977) stated that it could be a signal of low-return
business results if firms decide to sell equity to the outside investors and vice versa. In
addition, management purpose is also another reason that firms are not willing to issue new
stock to call for capital. Kenny Bell and Ed Vos (2009), concluded if given the
unconstrained choice between external debt and internal funds, SMEs will, in general,
choose not to utilise debt due to the preference for independence, control and financial
freedom. Consequently, the pecking order, firstly, starts with internal finance (using
retained earnings and adapting target dividend payout ratio to investment opportunities),
then continues with safe securities such as debt and convertible bonds if internal funds
provide insufficiently. Equity is only chosen as the last resort.
Given the importance of these two theories in capital structure, several empirical tests have
been conducted to examine the application of these theories in practice. The authors who
are supported for perking order theory, such as Shyam-Sunder and Myers (1999), by testing
116
117
(2)
Where MDR*i,t is the desired market debt ratio, is coefficient vector, and X i,t is the vector
set of firms characteristics. The trade-off theory suggests that # 0 and the variation in
MDR*i,t+1 should be non zero.
Firms would shift their leverage ratios forward the target ratio immediately in perfect and
frictionless market (there are no costs of transaction and adjustment). However, in an
imperfect world, immediate movement of debt ratio toward the desired ratio might be
prevented. Firms intend to adjust their leverages toward the optimal leverage level but
partially. Following the ideas of Rangan and Flannery, we construct a standard partial
adjustment model as follows:
(
(3)
In which, is the speed adjustment toward optimal leverage level of firm i at time t.
Substitute equation (2) into equation (3) we have the standard model which is used to test
the speed adjustment toward optimal level mentioned by the tradeoff theory.
(4)
118
(6)
119
120
121
Obs
Mean
Std. Dev.
Min
Max
1654
2008.710
1.671
2005
2011
1654
3.438
1.440
1.000
5.000
1654
0.299
0.283
0.000
0.900
1653
0.224
0.208
0.000
0.901
1574
-0.039
0.224
-1.181
1.834
1568
10.196
0.774
7.330
12.570
1654
26.536
1.436
23.220
31.201
1654
0.066
0.102
-0.901
0.609
1608
0.037
0.054
-0.650
0.750
1654
0.306
0.210
0.001
0.976
1654
20.826
12.752
5.000
67.000
1654
33.426
39.391
0.900
560.000
In average, the market debt ratio differs from book debt ratio an amount of 0.07 and they
both range from 0 to over 0.9 percent. This shows our data cover a wide range from nonleverage to heavy leverage-bearing firms. In fact, MDRs in some cases equaled to zero,
because, some firms have recently joined the market and they had no demand (or hard to
access) for long-term debt for some first years, whereas at some moments, MDRs of some
companies in construction industry were close to the value of 1 because at that time, the
price of outstanding shares decreased dramatically and the number of outstanding shares
was small too. Particularly, the maximum MDR is approximated to 1. Book debt ratio also
follows the trend of MDR. Values of BDR fluctuate from 0 to 0.9. The book debt ratio which
approximates 90% reflects the fact that firm heavily depended on outside resources and it
was in danger of bankruptcy. Beside that, average debt levels for MDR and BDR are around
0.29 and 0.22, respectively. This guarantees the sufficiency of our sample, a great range of
leverage ratio from different industries but with reasonable mean.
Data of other variables also present gaps among firms. We considered from very young firm
which was lately established within 5 years to very traditional and long-lasted history firm
which was operated over 60 years ago. With the wide set of data, we expected that our
empirical results could be applied to explain for financial behavior of all firm types. However,
some observations were abnormally far away from most of other observations as running
firm-level empirical analysis, outlier error was another issue that we considered. A paper
written by Ghosh and Vogt, in Joint Statistical Meeting of American Statistical Association,
2012, questioned on how small of the tail probability is to declare a value of an outlier. They
figured that while the outliers might not be in the range of the model or a pattern, most of the
observations seem to follow the same principles or satisfy the model. In general, treatments
for outlier issues are often conducted by one of these three methods: 1) keeping outliers as
normal data. In this case, we will ignore the issue of outlier and conduct the empirical test
with the whole sample of our database; 2) wisorizing the outliers at a given level (e.g. at the
level of 1% or 5%); and 3) eliminating/trimming outliers from database or the sample.
While wisorizing or eliminating outliers will create statically bias and undervalue the outliers
because of the significance impact by decreasing standard errors, keeping them as normal
data in regression process might lead to overvalue the outliers and may create remarkable
results which vary remarkably from the true population value. However, our database was
122
1.14
VIF
SQRT-VIF
Tolerance
R-Squared
1.10
1.05
0.9091
0.0909
1.17
1.08
0.8531
0.1469
1.23
1.11
0.8146
0.1854
1.11
1.05
0.9005
0.0995
1.13
1.06
0.8832
0.1168
1.02
1.01
0.9789
0.0211
1.20
1.09
0.836
0.164
Condition Number
1.6808
From table 2, VIFs, variance inflation factor, and Condition Number, index of the global
instability of regression coefficients, were all less than 2. That means each independent
variable could be considered as non-linear combination with other independent variables in
our model. Consequently, multi-collinearity is not a serious problem for our empirical
analysis.
Finally, to ensure the resulting standard errors are consistent with the panel autocorrelation
and heteroskedasticity issues, we used robust standard errors in our regression analysis.
123
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB
OLS
.0583***
(15.44)
-1.179***
(-20.11)
-0.042
(-0.42)
0.104***
(3.97)
0.001*
(2.41)
-0.002***
(-11.96)
1608
0.4473
(2)
Random
effects
.0882***
(15.61)
-.8922***
(-14.98)
-.1389
(-1.55)
.1301***
(3.77)
.0007
(1.05)
-.0016***
(-13.17)
1608
(3)
Fixed
effects
.0881***
(15.61)
-.8922***
(-14.98)
-.1388
(-1.55)
.1300***
(3.77)
.0007
(1.05)
-.0016***
(-13.17)
1608
.4054
(4)
(5)
(6)
OLS
(dummy)
Random
effects
(dummy)
Fixed
effects
(dummy)
.0407***
(11.20)
-1.116***
(-20.56)
.09005
(0.93)
.1662***
(6.67)
.0008*
(2.29)
-.0004**
(-2.73)
1608
0.5540
N
R2 (within)
t statistics in parentheses - legend: * p<0.05; ** p<0.01; *** p<0.001
.0544***
(9.85)
-.8392***
(-15.12)
-.0377
(-0.44)
.1906***
(6.00)
.0006
(1.03)
-.0001
(-1.27)
1608
.1374***
(9.88)
-.6361***
(-10.37)
-.0526
(-0.60)
.1784***
(4.08)
-.0024
(-0.65)
.0001
(0.60)
1608
0.4969
The empirical result regarding the relation between firm size and debt ratio is consistent with
the corporate finance theory when it suggests bigger firms borrow more debt than smaller
ones. An increase in total assets would also lead to 6% debt ratio increase. In addition, our
result is also consistent with other research findings when profitability (EBIT_TA) is
negatively related to the debt ratio and production capacity (FA_TA) is positively related.
This confirms that if one company is performing well and making profits, it might have more
internal funds to support operational activities such as investments and paying out dividends
to reduce the distress risks rather than borrowing funds. On the contrary, firms with higher
production capacities (fixed assets) use more debts because they may need more capital to
support new production development opportunities. The result of the MB variable in our test
showed that even the growth opportunity is significantly negative to the market debt ratio; it
might have no effect on the debt ratio when its tested coefficient only reaches around
0.2%.Unlike what normal theory has predicted, a negative relationship between non-debt
tax shields and debt tax shields, our result failed to find a significant effect of depreciation,
DEP_TA, on the firms leverage level. A similar result is also applied for the correlation
between FIRM_AGE and debt ratio. The firms history variable does not lead to a difference
in borrowing debts. A firm with a long history might have a smaller market to debt ratio than
newly established firms because they might have better trade-credit policies and vice-versa,
start-up firms might borrow more in order to purchase initial fixed assets.
124
125
(1)
(2)
(3)
(4)
OLS
Random
effects
Fixed
effects
OLS
(dummy)
.6344***
(15.89)
.0406***
(6.59)
-.3514***
-3.61)
-.0729
(-0.54)
.0694
(1.81)
.0007
(.08)
.0001***
(0.59)
531
.5878
.6268***
(15.62)
.0413***
(6.63)
-.3503***
(-3.58)
-.0760
(-0.56)
.0711
(1.84)
.0007
(1.10)
.0001***
(0.60)
531
0.1691
.0558
(1.12)
.2222***
(10.35)
.0882
(0.69)
-.1325
(-0.95)
.1253
(1.42)
.0781
(1.00)
.0003
(1.33)
531
0.2841
.6507***
(16.61)
.0365***
(6.31)
-.1982*
(-2.06)
.0580
(0.46)
.0493
(1.37)
.0004
(0.78)
-.0007**
(-2.63)
531
.6745
(5)
Random
effects
(dummy)
.6087***
(15.16)
.0391***
(6.31)
-.1961*
(-2.00)
.0535
(0.42)
.0596
(1.56)
.0005
(0.78)
-.0006*
(-2.53)
531
(6)
Fixed
effects
(dummy)
.1122*
(2.21)
.1141***
(4.12)
.1559
(1.28)
-.0379
(-0.28 )
.1021
(1.23)
.1564*
(2.10)
-.0001
(-0.53)
531
0.3842
(7)
GMM
0.438***
(4.530)
0.0981***
(4.230)
-0.333
(-1.48)
-0.116
(-0.29)
0.448**
(3.310)
0.001
(0.380)
0.00105**
(2.800)
531
Table 5 shows the trade-off theory testing results for private firms. Using the same
techniques inform the state-owned firm sample, the significant level seems to reflect the
same results as shown in Table 5. However, some features seem to lose their significance
on debt choice. Firm size and profitability maintain positive relationships with the debt level,
while the remaining parameters were insignificant in OLS, random and fixed effects
regression analysis. The support for trade-off theory of optimal debt level does not seem as
strong in fixed effects with dummies inclusive and GMM analysis, when we found only one
significant control variable determined for the long-run target debt ratio in each analysis.
Despite this, the results still show a strong significance at 0.1% between the current debt
ratio and the desired debt ratio. In the GMM analysis, we found the adjustment speed had a
value consistent with the results in OLS and random effects analysis. The coefficient
estimator of MDR at time t, which equals to 0.78 in the GMM model, predicts that the speed
of adjustment toward the optimal debt level of private firms is much lower than that of stateowned firms. While the speed of adjustment is 66% for state-owned firms, private firms only
adjusted at the rate of 32%. This result implied that private firms complete the required
adjustment speed within 37 months in order to close a leverage gap between the current
and optimal market debt ratios.
126
Random
Effects
Fixed
Effects
OLS with
dummy
0.745***
0.734***
0.0685
0.709***
(5)
Random
Effects with
dummy
0.683***
(22.58)
(22.03)
(1.54)
(21.74)
(20.57)
(2.29)
(9.36)
0.0224***
0.0232***
0.199***
0.0193***
0.0200***
0.0324
0.03
(4.38)
(4.45)
(11.15)
(4.12)
(4.10)
(1.43)
(1.81)
-0.325***
-0.325***
-0.159
-0.243**
-0.241**
-0.0758
-0.38
(-4.04)
(-4.01)
(-1.67)
(-3.28)
(-3.21)
(-0.88)
(-1.88)
-0.249*
-0.252*
-0.0757
-0.172
-0.177
-0.104
1.53
(-1.98)
(-2.00)
(-0.58)
(-1.47)
(-1.50)
(-0.84)
(1.72)
-0.0179
-0.0184
-0.025
0.0542
0.0578
0.149*
-0.16
(-0.52)
(-0.52)
(-0.35)
(1.66)
(1.72)
(2.27)
0.000182
0.000188
-0.00098
0.000294
0.00032
-0.00317
(-1.28)
0.00
(0.35)
(0.35)
(-0.22)
(0.60)
(0.63)
(-0.85)
(1.67)
0.000161
0.000163
0.000295
-0.000196
-0.000182
0.000264
0.00111**
(0.98)
(0.98)
(1.70)
(-1.16)
(-1.06)
(1.47)
(3.01)
771
771
771
771
771
771
771
R2
0.5938
0.0967
0.2550
0.6894
0.3004
0.4328
Control
Variables
MDR
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB
(2)
(3)
(4)
(6)
(7)
Fixed Effects
with dummy
GMM
0.0972*
0.780***
To clearly understand how private firms and state-owned firms depend on debt, we
conducted a mean regression test on the leverage levels of these two groups. The result
shows that both groups seemed to equally use debt to support for their financial demands. If
private firms, on average, preferred their market debt ratios to be around 0.3, state-owned
firms preferred virtually the same ratio, which was determined to be around 0.29. The gap
between private firms and state-owned firms market to debt ratios is only about 0.03.
Unfortunately, the t test is only valued at 0.26, which is less than 1.96, and the two-tailed p
equalled 0.796. Therefore, we were unable to provide any conclusions to suggest which
type of firm used more debt.
Table 6: Testing the difference between two means.
MDR
Private_firm
State_firm
Gap
Coef.
.3007
.2971
.0036
Std.Err
.0091
.0107
.0140
P> |t|
33.05
27.59
0.26
0.000
0.000
0.796
[95%
Conf.
.2829
.2760
-.0240
Interval
.3186
.3182
.0312
In conclusion, unlike Nguyen (2006), and Okuda and Nhung (2012), the first hypothesis of
the paper is rejected when we found no evidence to suggest state-owned firms use more
debt than private firms. However, we found an application of the trade-off theory in the
Vietnamese market, even though not all of the control variables determining a firms longrun target debt ratio were statistically significant. The second hypothesis is confirmed when
Information regarding both private and state-owned firms suggests that an optimal level
exists where the firms would maximize value by utilizing current resources.
127
128
FINDEF
N
(1)
(2)
(3)
(4)
(5)
OLS
Random
Effects
Fixed
Effects
OLS with
dummy
Random
Effects with
dummy
(6)
(7)
0.625***
0.625***
0.140**
0.625***
0.625***
Fixed
Effects
with
dummy
0.148**
(17.83)
(17.83)
(2.82)
(17.22)
(17.22)
(2.94)
(6.60)
-0.00191
-0.00191
0.00965
-0.00288
-0.00288
0.0110
-0.0135
(-0.26)
(-0.26)
(0.68)
(-0.38)
(-0.38)
(0.77)
(-0.47)
0.0248***
0.0248***
0.0609***
0.0268***
0.0268***
0.0497*
0.0421***
(5.19)
(5.19)
(3.44)
(5.33)
(5.33)
(1.99)
(3.44)
-0.154*
-0.154*
0.154
-0.0771
-0.0771
0.186
-0.112
(-2.08)
(-2.08)
(1.49)
(-0.96)
(-0.96)
(1.75)
(-0.80)
0.0813
0.0813
-0.0909
0.128
0.128
-0.0587
0.115
(0.69)
(0.69)
(-0.68)
(1.08)
(1.08)
(-0.44)
(0.49)
0.0421
0.0421
0.0297
0.0474
0.0474
0.0264
0.157
(1.43)
(1.43)
(0.41)
(1.57)
(1.57)
(0.36)
(1.89)
0.000272
0.000272
0.0341
0.000253
0.000253
0.0166
0.00127
(0.59)
(0.59)
(0.55)
(0.54)
(0.54)
(0.26)
(0.83)
-0.000255
-0.000255
-0.000263
-0.000555**
-0.000555**
-0.000274
0.0000264
(-1.46)
(-1.46)
(-1.38)
(-2.59)
(-2.59)
(-1.11)
(0.08)
-0.0544*
-0.0544*
-0.0360
-0.0404
-0.0404
-0.0285
-0.0383
(-1.98)
(-1.98)
(-1.18)
(-1.44)
(-1.44)
(-0.92)
(-0.62)
493
493
493
493
493
493
493
GMM
0.545***
Running the same regression with the database of private firms, we also found the results of
the financing deficit on a firms choice of debt that were consistent with state-owned firms.
Although FINDEF substantially alters market book and depreciation signs and the significant
coefficient level, there was no indication to reject the null hypothesis of the regression
testing. Therefore, the pecking order of using internal funds first and issuing equity as a last
resort should not be considered as the theoretical explanation for lending behaviors of
private firms.
129
(2)
(3)
(4)
(5)
(6)
Fixed
Effects
with
dummy
0.0782*
(7)
Control
Variables
OLS
Random
Effects
Fixed
Effects
OLS with
dummy
BDR
0.656***
0.608***
0.0963*
0.650***
Random
Effects
with
dummy
0.593***
(22.86)
(20.43)
(2.45)
(21.47)
(18.85)
(1.99)
(6.29)
-0.00267
-0.00342
-0.00512
-0.000707
-0.00139
-0.00482
-0.00334
(-0.39)
(-0.48)
(-0.55)
(-0.10)
(-0.19)
(-0.54)
(-0.14)
0.0177***
0.0193***
0.0462**
0.0186***
0.0200***
-0.0134
0.0332**
(4.53)
(4.60)
(3.30)
(4.64)
(4.59)
(-0.70)
(2.65)
-0.119*
-0.120*
0.00794
-0.103
-0.103
0.0103
-0.342*
(-2.03)
(-1.99)
(0.11)
(-1.74)
(-1.69)
(0.14)
(-2.54)
-0.268*
-0.275*
-0.208
-0.314**
-0.321**
-0.217
0.0880
(-2.51)
(-2.54)
(-1.75)
(-2.85)
(-2.87)
(-1.81)
(0.16)
0.0898***
0.0941***
0.0850
0.110***
0.117***
0.146**
0.216*
(3.42)
(3.38)
(1.54)
(3.98)
(4.00)
(2.67)
(2.47)
0.000220
0.000238
-0.00126
0.000237
0.000265
-0.00126
-0.000271
(0.57)
(0.56)
(-0.42)
(0.60)
(0.60)
(-0.43)
(-0.19)
-0.000155
-0.000165
-0.000255*
-0.000299*
-0.000289*
-0.0000751
-0.000362
(-1.35)
(-1.42)
(-1.99)
(-2.19)
(-2.08)
(-0.50)
(-1.31)
-0.0101
-0.0116
-0.0155
0.00609
0.00468
-0.0180
-0.0168
(-0.48)
(-0.55)
(-0.70)
(0.29)
(0.22)
(-0.81)
(-0.27)
708
708
708
708
708
708
708
CASH
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB
FINDEF
N
GMM
0.434***
The pecking order specification continued to be tested by using the market debt ratio (MDR)
instead of the book debt ratio (BDR). The results remain unchanged, compared to the
previous regression. Since the techniques were identical, we do not reiterate the results.
After completing all empirical tests, we concluded that the pecking order theory failed to
explain the capital behaviours of both private and state-owned companies in Vietnam from
2005 to 2011.
7. Conclusion
In conclusion, we found that an optimal level exists where firms are able to maximize their
earnings in the Vietnamese market. Our findings indicated that the pecking order theory is
not applicable for both state and private firms when the internal deficit does not rule out the
debt choice behavior of firms. Internal cash flow has no significant effects on the debt ratio.
Given the plausible features, both private and state-owned firms rapidly adjusted toward the
time-varying desired leverage level. While state-owned firms only needed 18 months to
close the gap between the current leverage level and target leverage level, private firms
needed double the time-period to fulfil the gap. This might imply that government
shareholders require a more constrained and precise debt policy, compared to other
shareholders in private companies. However, in the capital structure aspect, state-owned
130
Endnotes
i
We did not add R&D expenditures as a determinant of capital structure in our empirical analysis, because
most of listed companies in Vietnam do not seriously spend their money on research and development
activities. Therefore, R&D expenditures generally equal to zero or omit in the database.
ii In fact, we also conducted regression analysis by using wisorizing technique at a given 1% level as a
robustness check for outliers. However, we found that the results remained unchanged, compared to the
results we have described in main part of the paper. Therefore, to make the paper short and simple, we
decided not to provide wisorizing empirical results in our paper.
iii
Dummy variables here are considered as industry group (INDU) and year (YEAR) dummies. However, due
to the aim of our test is proving coefficients of Xi are non zero, hence, we do not present the regression
results of dummies variables in table 4 and other tables afterward.
iv
From Table 5 afterward, we will not report the description of Independent Variables X i,t as they are all
described in table 4 and section three.
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