Ảnh hưởng của sở hữu nước ngoài đến quy mô giá trị doanh nghiệp

Da Nang City
January 2016

Bachelor of Corporate Finance Thesis

“THE IMPACT OF FOREIGN OWNERSHIP ON CAPITAL STRUCTURE OF FIRM
LISTED ON HOSE”


BACHELOR OF CORPORATE FINANCE

GROUP 1

Table of Contents

2


BACHELOR OF CORPORATE FINANCE

GROUP 1

ACKNOWLEDMENT
In fact, this thesis would not be successful finished without the support, encouragement as
well as assistance, no matter much or less, direct or indirect of many people. During the
period from the start of study in university so far, we have received a lot of attention and
help by teachers, family and friends. We would like to send our sincere thanks to all FPT
University professors and lectures together with knowledge and enthusiasm to impart
valuable lessons for us during studying at school.
We would like to send our deepest and greatest gratitude to our supervisor M.FinVo Hoang
Diem Trinh. All the instruction and motivation given by her were great help in completing

this thesis and we are thankful for these invaluable times as well as being the best guider in
this strenuous journey.
Last but not least, our special thanks were extended to our families and friends, especially
parents. Our thanks also go to them for their support, encouragement and belief. We will
always appreciate their loves.

3


BACHELOR OF CORPORATE FINANCE

GROUP 1

ABSTRACT
There are several studies that have focused on diverse linkages of foreign ownership and
capital structure; however, some limitations still exist. There are some gaps in their
research.
Apparently, most previous studies have paid their attention on the impacts of foreign
investment on firm performance, but there is a lack of research about its influence on
decisions of financing. Theoretically, the relationship between foreign ownership structure
and capital structure has been established, but there are only a few empirical studies have
examined this linkage, especially in developing countries such as Viet Nam. Therefore,
there is limited anecdotal empirical evidence on the influence of foreign ownership on
capital structure, especially in developing countries likes Viet Nam. In fact, with the sharp
increase in globalization and foreign investment, equitisation process in Viet Nam, foreign
ownership has been being a kinds of ownership structure have recently become important
and common.
To fulfill these gaps, the research used data from 161 non-financial listed firms on HOSE
in Vietnam during the period 2009–2014 and employed pooled ordinary least squares,
random effects and fixed effects regression methods, and the dynamic panel generalized

method of moments for analyzing data to examine the linkage between foreign ownership
and capital structure in Viet Nam. Although various approaches were applied, all results
were consistent.
Additionally, foreign owners with experience, knowledge and incentives can help firms to
reduce agency costs of equity through actively monitoring the management. This research
also supports the argument that one of the greatest concerns of managers is to retain or
increase their control because it provides them with discretion in making decisions or
accessing their private benefits.

4


BACHELOR OF CORPORATE FINANCE

GROUP 1

LIST OF ABBREVITION
Characters
AEC
BLEV
BOD
CAPEX
CFO
DOL
EBIT
FDI
FEM / FE
FII
FO
FTA

GDP
HNX
HOSE
IMF
LIQ
MLEV
NPLs
PPMC
REM / RE
ROA
ROE
ROI
ROTC
SMEs
SOCBs
SOEs
TNG
TPA
VCCI
WTO

Meanings
Asean economic community
Book leverage
Board of director
Capital expenditure
Chief financial officer
Degree of operating leverage
Earnings before interest and taxes
Foreign direct investment

Fixed effects model
Foreign institutional investor
Foreign ownership
Free trade agreement
Gross domestic product
Ha Noi Stock Exchane
HoChiMinh Stock Exchange
International Monetary Fund
Liquidity
Market leverage
Non-performing loans
Pearson Product – Moment Correlation
Random effects model
Return on asset/ profitability
Return on equity
Return on investment
Return on total
Small and medium-sized enterprises
State-owned commercial banks
State-owned enterprises
Tangibility
Trans -Pacific Partnership Agreement
Vietnam Chamber of Commerce and Industry
World Trade Organization

5


BACHELOR OF CORPORATE FINANCE

GROUP 1

6


BACHELOR OF CORPORATE FINANCE

GROUP 1

LIST OF TABLES AND FIGURES

LIST OF TABLES
Table
Table 1
Table 2
Table 3
Table 4
Table 5
Table 6
Table 7
Table 8
Table 9
Table 10
Table 11
Table 12

Name
Net inflow portfolio equity of foreign investors (USD million)
Trading volume of foreign investors
Variables used in this study

Descriptive Statistics of foreign ownership, capital structure and
control variables
Correlation coefficients between measures of foreign ownership and
bool leverage ratio
Correlation coefficients between measures of ownership structure and
market leverage ratio
The effect of foreign ownership on capital structure – pooled OLS
regression
The effect of foreign ownership on capital structure – Random effect
regression
The effect of foreign ownership on capital structure – Fixed effect
regression
The effect of foreign ownership on capital structure – Fixed effect
regression with robust standard error
Systematic time-lagged regressions of impact of foreign ownership on
capital structure of firms listed on HOSE
Summary of result for hypotheses

Page
13
13
39
52
54
54
55
57
58
59
64

65

LIST OF FIGURES
Figure
Figure 1
Figure 2
Figure 3
Figure 4
Figure 5

Name
The Modiglinani and Miller (MM) theory
The capital structure
The effect of foreign ownership on capital structure - MLEV
The effect of foreign ownership on capital structure - BLEV
Four steps in the deductive approach research

Page
23
25
33
34
42
7


BACHELOR OF CORPORATE FINANCE
Figure 6
Figure 7

Research progress
Panel data analysis’s conceptual framework

GROUP 1
44
50

8


BACHELOR OF CORPORATE FINANCE

GROUP 1

CHAPTER 1: INTRODUCTION

1.1 Research background
In the world of increasing globalization, foreign investment is a trend for all companies
over the world. Being a strongly emerging developing economy, Vietnam has become an
attractive market for investment inflows. As a matter of fact, there has been a growing
overseas cash flow into the country. In recent years, foreign investment in the industrial
sector in Vietnam has established the development and promoting economic growth.
Moreover, to be keep pace with the borderless trade as well as pave the way for foreign
funds into domestic companies, Vietnam government has enacted The Law of Foreign
Investment in Vietnam since 1987. Up to now, the law has been amended many times and
the latest amendment is in the beginning of 2014 to extend the maximum rate of foreign
ownership in domestic commercial bank. From this, it is indicated that foreign investment
not only contributes to the process of integration with the world economy of Vietnam but
also plays a very important role for our country's economy. Most of the Vietnam
enterprises previously are owned by the state and dependent on the funding from the

government. However, in the context of economic reform from the mid 80’s onwards, a
number of enterprises were privatized and rapidly developed with the diversity in
ownership structure such as private ownership, foreign ownership and joint-stock
companies. That is reflected by strong economic growth, the participation in the World
Trade Organization (WTO - 2007) as well as Trans-Pacific Partnership Agreement and the
establishment of Vietnam stock exchange market in 2000. The prosperity of corporations
depends greatly on the access to appropriate source of capital such as debt or equity, as
well as determining the optimal capital structure. Upon the advancement, Vietnam though
is in lack of the diversity of financial channels and empirical researches which are
consistent with the reality of capital structure so that they can support enterprises to make
appropriate financing decisions.

9


BACHELOR OF CORPORATE FINANCE

GROUP 1

1.2 An overview about foreign ownership in Vietnam
1.2.1 Vietnamese listed firms
The number of listed firms has been increasing noticeably since 2000. Specifically, on the
first trading day, only two stocks with a total market capitalization of USD 27.95 million
were listed. In the next five years, the growth by number of listed companies was rather
slow. However, the situation changed quickly in the period 2006–2013. The number of
listed companies increased sharply from 193 in 2006 to 696 in 2013 (HoChiMinh Stock
Exchange [HOSE] 2013).
An examination of the ownership structure of listed firms reveals that, although the
proportion of shares owned by foreign investors in Vietnam is limited to 49% by law
(Robinson 2012), this ownership is an essential part of the ownership structure in listed

firms in Vietnam. In terms of state ownership, through the privatization programs, the
average of state ownership dramatically decreased; however, state ownership still accounts
for a significant proportion of listed Vietnamese firms. Another point is that the percentage
of foreign and state ownership varies considerably from industry to industry, and from firm
to firm. Foreign ownership is significantly higher in healthcare, oil, gas and technology,
which also have high performance in both accounting and market value. Hence, questions
can be raised regarding whether relationships exist among ownership structure and capital
structure.

1.2.2 Foreign investment in Vietnamese stock market
During the global financial crisis of 2008, the net foreign inflow into the Vietnam equity
market decreased sharply before recovering in recent years. The net foreign portfolio
inflow was higher than those of Indonesia, Thailand and Philippines, reaching USD 1.3
billion in 2013 (see Table 1). The Vietnam stock market is becoming more and more of an
attractive investment channel for foreign investors, and the market expectation is for
continued growth in foreign portfolio investment inflows in the future. This can be
explained by the fact that Vietnam is an emerging market with a high growth rate and that
the Vietnamese firms are undervalued and considered cheap compared with their regional
peers in Asia (Rong Viet Securities 2011, 2014).

10


BACHELOR OF CORPORATE FINANCE

GROUP 1

Table 1: Net inflow portfolio equity of foreign investors (USD million)
(Source: icator)
Among the over one million investors in the Vietnam stock market, foreign investors

account for a modest number, around 1% to 2% of total investors. However, foreign
investors play an important role through their trading activities. Their volume of market
trading occupied 15% of the HOSE market in the period from 2011 to 2013 (HOSE 2012,
2013).
Year
2010
2011
2012
2013

Foreign Trading volume

Total Trading
volume
1,767,527,356
11,643,346,488
1,296,896,130
8,281,562,409
2,357,729,515
13,980,559,995
2,366,155,883
16,078,051,147
Table 2: Trading volume of foreign investors

% Total market
15.18
15.66
16.68
14.72

(Source: Calculated from State Securities Commission of Vietnam (www.ssc.gov.vn)
As a result of economic and political reform, Vietnam has begun to grow strongly and
occupy an important position in the South-East Asian market. Vietnam has had high
growth rates in its GDP in recent years and is one of the developing Asian countries that
has a high economic growth rate (IMF 2010). It is also one of the highest recipients of FDI,
averaging over 7% of its GDP between 2005 and 2013(World Bank 2011, 2014). The
country’s economy has good prospects given its strong export performance within the
ASEAN countries (Viet Capital Securities 2011) and the profitability expectations of its
top firms (Grant Thornton 2011). With respect to the equitisation process, it resulted in a
number of privatized firms, at a somewhat modest level. State ownership continues to be a
popular ownership structure in Vietnam (World Bank 2011).

11


BACHELOR OF CORPORATE FINANCE

GROUP 1

Regarding the financial market, although the Vietnamese banking sector has diversified in
terms of type, size and ownership in recent years, the industry is still concentrated in four
SOCBs, which occupied nearly 50% of the total loan and deposit market in 2013 (VPBank
Securities 2014; VCCI 2013). A noticeable point is that nearly one-third of bank loans is
distributed to SOEs, whereas SOEs account for only around 1% of registered firms. In
addition, SOEs normally have a higher debt ratio than non-state and foreign firms, while
their returns are lower and 70% of NPLs of the bank sector were to SOEs in 2012
(VPBank Securities 2014). Therefore, this suggests that a firm’s ownership structure may
affect its ability to access bank loans.
Similarly, Vietnam’s bond market is still dominated by entities that to some extent have a
relationship with the state or national government. A majority in both number and size of

bonds are issued or guaranteed by the government. Only some large joint-stock companies
are able to raise funds by issuing bonds. The dominance of SOEs and large corporations in
the corporate bond market may affect SMEs’ ability to access this debt financing option.
Vietnamese stock markets have been developing gradually and becoming an important
financing channel for corporations. The markets are becoming more and more of an
attractive investment channel for foreign investors and are expected to gain stronger
foreign portfolio investment inflows in the future. In addition, it is observed that foreign
ownership in listed firms is increasing significantly, and increasingly playing an important
role in listed firms’ performance.

1.3 Research questions
The purpose of this research is to study the impact of foreign ownership on the capital
structure of firms listed on Ho Chi Minh Stock Exchange. Authors generate ideas from the
research question:
Does foreign ownership influence the capital structure of firms listed on HCM Stock
Exchange?
How does foreign ownership affect the capital structure of companies listed on HCM Stock
Exchange?

12


BACHELOR OF CORPORATE FINANCE

GROUP 1

1.4 Research Objectives
This study pays much attention on investigating the influence of foreign ownership over
financial leverage. Thus, the main objects of the study are
• Clarify the relationship between foreign ownership and capital structure of firms.

• To give recommendation about the relationship between foreign ownership and capital
structure.
However, besides foreign ownership, in order to reduce the bias of other factors on the
leverage, we also focus on utilize six more variables which are hypothesized to have
relationship with leverage. Finally, the best reasonable model would be found.

1.5 Research scope
The scope in this study investigate the data from 161 firms, which include the companies
have foreign ownership as well as are listed on Ho Chi Minh Stock Exchange.
Based on the economic data, this study is conducted based on the number which is
collected from 161 companies with the time horizon within 5 years, from 2010 to 2014.

1.6 Research methodology
Research approach
To get the purpose, this research applies the deductive approach in order to analyze. The
timeline for researching project is limited, therefore the inductive method is impossible.
Research method
All the data are used in this research are the numerical data, so the most suitable method
for this project is quantitative. Furthermore, the time horizon is longitudinal.

1.7 Data overview
The data is collected in the study is secondary data and from audited financial reports
which are owned by Vietstock security company and issued to public.
After gathering and authority sources, the data are processed by Microsoft Excel 2013,
Stata software to run the regression.

13


BACHELOR OF CORPORATE FINANCE

GROUP 1

1.8 Thesis structure
This thesis contains five chapters. The main content of each chapter is as below.
Chapter 1: Introduction
Illustrates a background of the study, research relevance, research question, research scope
and the overview of the structure.
Chapter 2: Literature review
Review all the literature which related to the research questions, preceding relevant
research and selected theoretical models.
Chapter 3: Methodology
Explaining how to collect and analyze the data as well as limitation of the research project.
Chapter 4: Data analysis and finding
Conducting the data process by systematic running presentation. Analyze and discuss the
findings that relate to literature review.
Chapter 5: Discussion and recommendation
Present the relevance of answer and recommendations.

1.9 Limitation
The research analyzing only based on the data of Ho Chi Minh Stock Exchange, therefore
it cannot reflect the comprehensive outcome and accurate appraisal for whole firms in
UPCOM and HNX.
Secondly, due to the lack of time for researching, the limited of education and this study
investigate the period of five years from 2010 to 2014. Thus, the findings are collected
cannot illustrate clearly and reliable about the impact of foreign investment on capital
structure.
Last but not least, according to theoretically, the variables are independent. By contrast in
real life, there are still a relationship between these variables, so some results would have
bias effect.

14


BACHELOR OF CORPORATE FINANCE

GROUP 1

1.10 Conclusion
Thanks to the result the political and economic reform, Viet Nam has begun to grow
rapidly and constitute a large and important role in South-East Asian market. Recently,
Viet Nam has seen a high growth rates in its GDP, hits five-year high of 6.68% (Office,
2015).
Vietnam has had witnessed a high growth rate in its GDP in few recent years and
becoming one of the developing Asian countries that achieved a high growth rate in
economic. Besides Viet Nam also an attractive place for FDI investment thanks to the
support of many FTA such as TPA, AEC, etc. The Vietnam’s economy also has a good
fortune due to strong export performance when compared with other ASEAN countries
(Viet Capital Securities 2011) and the profitability expectations of its top firms. (Grant
Thornton 2011).
In addition, the stock market of Viet Nam has been growing gradually and becoming the
important financing channel for many firms. Thanks to some policies and free trade
agreements, the markets are becoming more and more an attractive investment channel for
foreign investors. Moreover, institutes are expected to gain stronger foreign portfolio
investment inflows in the future. The clearly evidence was given that the value of
investment by foreigners in Vietnam stock market so far in 2015 was a net $135.5-million
according to Bloomberg data and it will rise significantly with the new regulation. (Gulfstime)
Ultimately, it is reported that foreign ownership in listed firms is growing rapidly, strongly
and occupy more and more important role in listed company structure.

15


BACHELOR OF CORPORATE FINANCE

GROUP 1

CHAPTER 2: LITERATURE REVIEW AND THEORETICAL
MODEL

2.1. Introduction
The aim of this chapter is the literature review on the ownership and capital structure, in
particular, the influence of ownership structure on leverage as well as of leverage on firm
performance. Agency theory is widely in order to explain the relationship of capital
structure with ownership structure. It states that the structure of ownership can influences
agency costs and subsequently affects capital structure decisions. (Jensen, 1976)Meckling
and Jensen (1976) claimed that there are two different types of agency costs. The first type
is the costs of equity caused by the conflict among shareholders and managers.Secondly, as
the conflict of debt holders and equity holders create the costs of debt. Managers are
widely responsible for their decisions; nevertheless, they do not gain fully from their profit
activities. Therefore, managers may choose a capital structure of firm to pursue their own
interests instead of those of shareholders or debt holders. This theory also suggests that
outside ownership through a monitoring mechanism could mitigate the conflict between
managers and shareholders. It implies that different types of ownership could have
different effects on the firm’s capital structure decisions.
Modigliani-Miller (MM) theory (Modigliani, F., and Miller, M.H, 1958) posits that firm
value is not influenced by its capital structure. However, this theory is based on restrictive
assumptions of a perfect capital market that does not exist in the real world. To account for
an imperfect market, the four main theories that have been suggested as alternatives to MM
theory are tradeoff, pecking order, market timing and agency theory. The theory of tradeoff noted that a company will trade off cost and benefit of debt to maximize the value of

firm. The debt primarily benefit comes from the tax shield of reducing income through
paying interest (Miller, MH & Modigliani, 1963). The cost of debt is derived from indirect
together with direct bankruptcy costs through the increase in financial risk (Kim, WS &
Sorensen, 1986) (Kraus, A &Litzenberger, 1973). The theory of pecking order (Myers S.C.
and Majluf N., 1984) (Ross, 1977) proposes that financing follows hierarchy: first of all is
using internal financing, then issuing debt, and equity is issued while no more debt can be
approach. The theory of agency cost, developed by (Jensen, M. and W. H. Meckling, 1976)
16


BACHELOR OF CORPORATE FINANCE

GROUP 1

(Jensen, 1986) and (Hart, O & Moore, 1994), contends that there are target conflicts among
debt holders, managers, shareholders and an optimal capita structure to maximize value of
firm which helps to minimize total agency costs.The last is the market timing theory. This
theory describes how firms and corporations in the economy decide whether to finance
their investment with equity or with debt instruments (Marsh 1982) (Grahan and Harvey
2001).

2.2. Relevant Concepts
2.2.1. Capital Structure
(Rouf, 2015) Capital structure refers to the mix of a firm’s debt and equity’s financing,
such as debentures, preference share capital and equity share capital including retained
earnings. Capital structure is one of the most complex areas of financial decision making
because of its interrelationship with other financial decision variables.
Capital structure is the way a firm raising capital to support its operations and future
growth by using composition of debt and equity. Debt financing and equity financing are
two main capital sources in business. Firms issue more debt bear high risk. An optimal

capital structure should be the balance of debt and equity. Debt can be classified as long
term debt and short term debt, long term debt includes bonds, long term loan and long-term
notes payable. Short term debt consists short term bank loan and account payable. Equity
capital usually consist common stock, preferred stock and retained earnings. Most firms
employ the combination of debt and equity to finance their assets to minimize costs of
capital. The formed capital structure is usually referred as leverage.

2.2.2. Ownership Structure
The structure of ownership contains a various of definitions. Meckling with Jensen (1976)
classified this structure in terms of capital contributions that comprise of outside
shareholders (debt holder and equity holder) as well as inside investors (manager).
(Damanpour, 1991)Chaganti and Damanpourclaimed there are two ways of classifying
ownership. The first distinguishes between those who directly affect firm decisions and
activities—a situation that is called ‘involvement’—and those who do not, which is called
‘detachment’. The second way distinguishes firms that have stocks concentrated with some
shareholders, which is called ‘concentration’, and firms whose stocks are dispersed to
17


BACHELOR OF CORPORATE FINANCE

GROUP 1

many shareholders, called ‘dispersion’. The crossing of these two classifications creates
four kinds of ownership: concentrated–involved, concentrated–detached, dispersed–
involved and dispersed–detached. A point worth noting is that shareholders whose
ownership are more involved and concentrated have a strong influence on firm
performance.
(Abel Ebel, 2010) Abel Ebel and Okafor categorized structure of ownership as the shares
percentage which are held by government (state ownership), institution (institutional

ownership), managers (managerial ownership), and family (family ownership), foreign
investors (foreign ownership), etc. (Fazlzadeh, 2011)Fazlzadehstated that this structure has
both implications: identity of ownership concentration and owners, that is, the
complementation of shares owned by managing investors.

2.3. Review of theories
In general, there are many ways for a firm generating fund for its operation as well as
business projects. Concerning the source, financing activities are divided into internal
funds and external channels.
When the chief financial officer considers raising capital for company, the first source is
internal source which comes from retained earnings. That is profit after tax of the
corporation accumulated from year to year. Thus, utilizing the available capital is
advantageous because of its low cost. The company does not bear the interest for creditors
or pay out the dividend for shareholders.
Regarding the external sources, borrowing and equity are two main ways for financing.
The former means loans from outside while the other refers to sell shares including
common stocks or preferred stocks to get investment for the company. However, each type
of source has its own benefit and risk.
As borrowing money, the company commits to pay an amount of interest periodically and
make principle repayment at maturity. However, the paid interest is tax deductible,
resulting in lower cost of capital. Lenders get their fixed return and have no additional
income if the project is successful and money – making. In other hand, there are some risks
such as lower liquidity ratios and higher solvency indexes. That is disadvantageous for the
firm due to higher cost of borrowing. In addition, the amount of borrowings is in priority to
pay back in circumstance of bankruptcy.
18


BACHELOR OF CORPORATE FINANCE

GROUP 1

Notwithstanding, companies have limited liability. It means that the promise to repay the
principle is not always kept. If the firm is in deep water, it is allowed to default on debt and
transfer their assets to the creditors.
In addition, there exists a kind of debt that can be converted into equity called convertible
bond. This kind of bond provides its owner the option in order to transfer to a fixed number
of shares. When company’s share price increases significantly, the bond may be converted
to get profit. Conversely as the stock price falls, there is no obligation to turn the bond into
equity. Owing to that privilege the convertible bond is sold at a higher price or enjoys a
lower interest rate than ordinary ones.
As a matter of fact, a company chooses to issue stocks for fundraising means selling its
ownership. Unlike debt, there are no principle and no interest while dividend is paid out
according to corporate policy, business profitability and type of share. Yet, paid dividend is
not allowed to deduct from taxable income since it is calculated as an after tax payment.
As known, the firm’s net worth is a sum of common stocks and preferred stocks. Although
preferred equity is considered to be less important than the other, there are certain
particular situations in which it is a useful financing method such as merging with other
corporation. Like debt, there is a predetermined payment of return regardless of the annual
company bottom line and discretion of managers. The company has rights not to pay the
dividend but no dividend on common shares is paid until that on preferred stocks is settled.
If the firm goes bankruptcy, the preferred stock holders take priority over the common
share holder but queue after the lenders. Moreover, it is not allowed to deduct dividends on
preferred share from taxable income, which is one of the dominant deterrents for industrial
companies to issue preferred (Brealey R. A., Myers S.C., 2000)
Other distinguishing character of preferred stock is limited voting rights. This is favorable
method for company to do financing without distributing control with new stake holders.
By and large, the combination between debt and equity that a company utilizes to raise
capital for their operation is capital structure. The financial manager is responsible for
mitigating the costs of capital as well as maximizing the company value by choosing a

proper capital structure.
However, principle–agent problem is worthy to consider. The conflict interest between
owners and managers often has impact on the financing decision. Also, the announcement
19


BACHELOR OF CORPORATE FINANCE

GROUP 1

of new share issued sends a bad signal to public about the profitability of business
activities. While borrowings and debt certificate issuance confirm the confidence in
projects of company managers. Besides high financial leverage is too risky because the
great amount of interest payment will erode the bottom line. This causes negative effect on
financial situation of the company such as liquidity, solvency and valuation ratios.
The theory of the Miller’s and Modigliani (1958) “Irrelevance theory of capital structure”
paved the way for other models of financial leverage of economists. (Modigliani, F., and
Miller, M.H, 1958)
Capital structure is defined as dominant controversies of scholars in modern corporate
finance in the latter half of 20th century. Up to now, there are four additional widely
acknowledged theories, which from the assumption of perfect market applied by
Modigliani and Miller, are divergent. Firstly, the theory of trade-off anticipates that
companies trade off the gain and charge of debt and equity financing together with finding
out an “optimal” capital structure when accounting for market imperfections including
bankruptcy costs, taxes and agency spending. Other is the theory of pecking order (Myers
S.C. and Majluf N., 1984) which defends that firms apply a financing hierarchy to
minimize the information asymmetry problems among the outsider’s shareholders and the
firm’s managers-insiders.
In addition, in 1976, Jensen and Meckling developed a research about agency cost theory
which has impact on corporate capital structure. That explains the conflict interest of

principle – agent resulting in the cost for firm to adjust the deviation between two parties
including manager – equity holder and debt holder – share holder.
Recently, (Baker M. and Wurgler J., 2002) have suggested a current capital structure
theory called the “capital structure market timing theory”. This hypothesis announces that
to time the equity market, new structure of capital is the additive final result of past
attempts. Market timing expresses that companies issue new shares since they are
overvalued as well as buy bac shares if they estimate these are underestimated. By others,
that issuing behavior was well established already. In contrary, Wurgler and Baker show
that the influence on capital structure of market timing is extremely persistent.

20


BACHELOR OF CORPORATE FINANCE

GROUP 1

2.3.1. The Modigliani and Miller theory
The modern corporate finance’s theory is pioneered by the research of Modigliani and
Miller (1958) about the irrelevant proposition of capital. Modigliani and Miller have to
learn about the details of increasing or decreasing capital as a firm borrowing increase or
decrease. Proving a feasible theory, Modigliani and Miller initially hold some assumptions
in financial theory as followings:
• Perfect competition in capital markets
• Investors have identical expectation
• Borrowing and lending with low risk.
• No agency cost
• Investment decisions are unaffected by financial decisions.
Modigliani and Miller (MM) theory includes the first proposition which proves the firm’s
value is unaffected by the capital structure and also the second proposition which explains

increasing in the cost of equity as a firm increases the proportion of debt financing. Both
propositions are assumed to be excluded from taxes. (Source: Modigliani and Miller, 1958)

Figure 1: The Modiglinani and Miller (MM) theory
That research is successively both controversy and clarity. As the problem of theory, the
capital structure which is irrelevant can be demonstrate through restrictive assumptions.

21


BACHELOR OF CORPORATE FINANCE

GROUP 1

This paper encouraged considerable research that commit to relaxing the inappropriateness
as an empirical matter or matter of theory also. The research has indicated that the
Modigliani & Miller’s theory fails under various circumstances. Transaction costs, agency
conflicts, taxes, lack of separability between operations and financing, investor client
effects, time-varying financial market opportunities, bankruptcy costs, adverse selection
are elements which are used generally. Other factors from this list were employed by
alternative model. With the variety in ingredients, there are many different theories has
been advanced. It is beyond the scope of this paper to cover all these.

2.3.2. The tradeoff theory
By different authors, the term trade-off theory is applied to give a description about a
family of related theories. In that, decision makers managing a company evaluate the
variety costs and benefits of alternative leverage agendas. It is showed that an inside
suggestion is received, then marginal cost with benefit are equaled.
The first kind of this theory developed out of the argumentation over the Modigliani-Miller
theorem. Adding corporate income taxes to original irrelevance, it made a welfare for debt

and worked for shield earnings from taxes. When there is no offsetting debt cost and the
company objective function is linear, it implied 100% liability financing.
Some characteristic of Myers’ explanation of the exchange deserve explanation. First off
all, its goal is no noticeable directly. It might be attributed from evidence but still relies on
adding a framework. Furthermore, different articles use that frame in various steps. Next,
by the theory, there is much more multiplex tax code than being supposed. Since
depending on included tax code features, the different final decisions considering the goal
can be got. Thirdly, the cost of bankruptcy defined as deadweight cost more than transfer
from a claimant to another and the costs nature are also special. Next, the expenses of
transaction need to take a particular form for the analysis in order to act. When the
improvement is larger, the adjustment marginal costs have to raise for alternation the to be
step by step rather than abrupt.
When accumulated retained earnings are invested to opportunities which are not really
good, the BOD may take detrimental actions to the interests of the owners and bringing
particular benefits for themselves. A typical example is the board of directors may use
surplus funds to implement the non- acquisition - merger which does not bring value to the
company, aiming to increase power and their paychecks. Or the board might spend a
22


BACHELOR OF CORPORATE FINANCE

GROUP 1

wasteful or inefficient cumulative value of the owner. Michael Jensen (1986) emphasizes:
"The problem is how to pay for the board of directors instead of the lower capital cost
investment or squandered them in the inefficient operation “.
Conversely, capital structure employs a lot of debt, with fixed interest payment and
principal repayment putting pressure on the management of BOD in more effective way
than the company's cash flow. That helps regulate the BOD avoiding risky investment,

improving in its performance and minimizing conflicts of interest between managers and
shareowners.
Static trade-off theory
The mentioned theory affirms that companies have best structures of capital, which are
found by interchange the cost against the benefit from the utility of equity and debt. The
advantage of debts tax shield is one of the strong point of debt using. By contrast, one
weak point of debt is the potential financial distress cost, especially since a firm depends
on liability a lot.
They lead to an exchange already between the tax shield and much more financial distress
risks. However, there are more costs and profits included with the benefit of equity
together with debt.

Figure 2: The capital structure
(Source: The capital structure puzzle, Myers, 1984)

23


BACHELOR OF CORPORATE FINANCE

GROUP 1

The other significant cost factor involves agency cost. These cost stems from battles of
interest among the various stakeholders of a company and due to ex-post asymmetric data
(Jensen and Meckling (1976) and Jensen (1986)) (Jensen, M. and W.H. Meckling, 1976).
Therefore, incorporate agency costs into the trade-off theory static means that a firm
discovers its structure of capital by interchange the advantage of debt tax against the
financial cost distress of large amount debt and the debt cost against the agency equity
cost. Another function was recommended under the tradeoff holism, then this leads to far
to discuss them all. Hence, these discussions end with the declaration that a valuable

forecast is that one company sets goal with its capital structure, i.e. When the existent
leverage ratio departs from the optimal, a company may naturalize the behavior by a
solution that delivers leverage rate back to original level.
The Dynamic Trade-off Theory
The time role requests to specify a variety of features which are typically rejected and is
recognized by constructing models in single-period system. Particularly, the noticeable
points are the functions of adjustment versus expectation cost. In this dynamic theory, a
right financial conclusion regularly relies on the margin that the corporate expects in the
following period. Several organizes willing to pay out funds at that time, while others
choose raising money. If fund is increased, it might take the form of equities or debts.
Finally, firms under takes a collection of those actions.
Stiglitz (1973) was a special predecessor to modern the theory of dynamic trade-off, who
checks over the taxation influences from a public financing orientation. As companies
respond to adverse dazes contiguously by balancing costless again; companies converse
high levels of debt to take tax savings pros.
To the next period, the models of dynamic trade-off could be applied to identify the
options values inserted in departing leverage selections. Goldstein et al. (2001) observed
that firms with not high leverage nowadays might have the consequent option to make
leverage grew up. By those assumption, that option in the future is served in order to
decrease the otherwise leverage optimal level it the current time. Again, due to transaction
costs, if corporates optimally finance in periodical manner, the liability ratio of most of
organizes will turn from the optimum nearly all the period. In this theory, the leverage of
firm answers more about long-run value change and less about short-run equity fluctuation.

24


BACHELOR OF CORPORATE FINANCE

GROUP 1

Overall, a definite idea is fairly in dynamic trade-off models. In the future, the financial
optimal today choice relies on what is trusted to be optimal. Furthermore, it might be the
best to pay them out or to raise money. When new funds are increased, it can be important
to increase them in the frame of equity or debt. In each situation, the pertinent examination
for the company in the current time will be helped to pin down by what are estimated to be
the best in the following period.

2.3.3. The pecking order theory
The pecking order theory is essentially depending on the great concern about asymmetric
information that affect the investment decisions and financial decisions of the business.
Because management board knows more future information than the external investors so
the new investor will require a high discount in time firm issue stocks. It brings about the
cost of external financial sources become more expensive. As a result, when enterprises
need equity capital, they usually use the source of internal funds first (company retained
their profits), next is bonds and the last option is issuing new shares capital.
The research of Myers and Majluf (1984) has shown that the financial trends of behavioral
deviation stems from asymmetric information. It is clear that their analysis has two main
points. Firstly, the cost of the new release depends on external financing. It includes
management costs, insurance costs and the cost under the price of the new shares. All these
things make the administrators consider issuing new share. When the current net value of
stock higher than net present value of investment activities, the benefit form the new shares
release must be guaranteed. Secondly, the facilitation of the issuance debt must be greater
than issuing equity capital.
Based on the study by Ross (1977) and Myers (1984), the pecking order theory explains
the different debt ratios between companies in a sector. Furthermore, asymmetric
information makes investors always think they know little information than the chief
financial officer (CFO) about the prospects, potential and value of the company. Therefore,
they always act to protect themselves in the market by the direction that always
undervalued newly issued shares, increase or reduction in dividends and high valuation

with shares, increasing the dividend payout ratio or debt (Frank and Goyal 2007).
Enterprises issuing debt securities or equity securities usually follow the trend of priority
as internal financing, mainly retained earnings, then the issuance of debt and finally when
the funding sources have been exhausted, it released new capital stock. If enterprises
25