Evidence on market to book value and firm performance a study of listed firms in vietnam

MINISTRY OF EDUCATION AND TRAINING
UNIVERSITY OF ECONOMICS HOCHIMINH CITY
--- oOo ---

NGUYEN TUONG PHUONG

EVIDENCE ON MARKET-TO-BOOK VALUE
AND FIRM PERFORMANCE:
A STUDY OF LISTED FIRMS IN VIETNAM

MASTER THESIS

Ho Chi Minh City – 2011


MINISTRY OF EDUCATION AND TRAINING
UNIVERSITY OF ECONOMICS HOCHIMINH CITY
--- oOo ---

NGUYEN TUONG PHUONG

EVIDENCE ON MARKET-TO-BOOK VALUE
AND FIRM PERFORMANCE:
A STUDY OF LISTED FIRMS IN VIETNAM

MAJOR:
FINANCE & BANKING
MAJOR CODE: 60.31.12

MASTER THESIS
INSTRUCTOR

:

DR. TRUONG TAN THANH

Ho Chi Minh City – 2011


ACKNOWLEDGEMENT
I would like to expess my sincere gratitude to my instructor, Dr. Truong Tan
Thanh for guiding me throughout this thesis.
My appreciation to all of my teachers at Faculty of banking and finance,
University of Econimics Hochiminh City for their teaching and guidance during
my MBA course.
I would like to dedicate my deepest gratitude to my parents and my uncle for
their support and encouragement.

i


ABSTRACT
This study tries to interprete the relationship between market to book value (a
proxy of growth opportunity) and firm performance based on capital structure
theory, tradeoff theory and costly external financing theory, and other studies
relative to this topic. The author uses cross-sectional data 2009 and 2010 of 70
listed companies in Vietnam to investigate the effect of market to book on
firm‟s performance. As the results of this study, price to book value is the
important determinant of firm performance. This finding supports the argument
of Xu et al (2005), Fairfield (1994), Block (1995), Frank et al (2005) and Myers
et al (1984). Firm leverage has significant and negative impact on firm‟s

performance, which is consistent with the results of Modigliani and Miller
(1958), Robichek and Myers (1966), Jensen and Meckling (1976), Frank et al
(2005). Firm size has negative and significant correlation with firm‟s
performance, which contrasts with Titan & Zeitun (2007). Beta has negative
influence to market to book ratio. This finding is consistent with Damodaran
(2002), Myers and Majluf (1984), Baker and Wurgler (2002), Harris and
Marston (1994). Firm performance in 2009 has positive influence to growth
opportunity (Pb) in 2010. This result favours Damodaran (2002), Block (1995).
Industry has influence to firm‟s performance.
Keywords: Market to book value, corporate performance, Vietnam, HOSE,
HNX.

ii


TABLE OF CONTENTS
ACKNOWLEDGEMENT -------------------------------------------------------------------------------- i
ABSTRACT ------------------------------------------------------------------------------------------------- ii
TABLE OF CONTENTS---------------------------------------------------------------------------------- iii
LIST OF FIGURES ---------------------------------------------------------------------------------------- iv
LIST OF TABLES ----------------------------------------------------------------------------------------- v
CHAPTER 1: INTRODUCTION ----------------------------------------------------------------------- 1
1.1 BACKGROUND --------------------------------------------------------------------------------------- 1
1.2 RATIONALE ------------------------------------------------------------------------------------------- 2
1.3 RESEARCH PROBLEMS ---------------------------------------------------------------------------- 6
1.4 RESEARCH OBJECTIVE ---------------------------------------------------------------------------- 7
1.5 RESEARCH METHODOLOGY AND SCOPE---------------------------------------------------- 8
1.6 STRUCTURE OF THE STUDY --------------------------------------------------------------------- 9
CHAPTER 2: LITERATURE REVIEW -------------------------------------------------------------- 10
2.1 INTRODUCTION -------------------------------------------------------------------------------------- 10

2.2 CASHFLOW INTO EMERGING MARKETS----------------------------------------------------- 10
2.3 PRICE TO BOOK VALUE --------------------------------------------------------------------------- 12
2.4 FIRM PERFORMANCE ------------------------------------------------------------------------------ 14
CHAPTER 3: RESEARCH METHOD ---------------------------------------------------------------- 17
3.1 INTRODUCTION --------------------------------------------------------------------------------------- 17
3.2 DATA ----------------------------------------------------------------------------------------------------- 17
3.3 RESEARCH METHOD -------------------------------------------------------------------------------- 17
3.4 RESEARCH SAMPLE --------------------------------------------------------------------------------- 18
3.5 VARIABLES MEASUREMENT FOR MODEL --------------------------------------------------- 19
3.5.1. Dependent Variables --------------------------------------------------------------------------------- 19
3.5.2. Independent Variables ------------------------------------------------------------------------------- 20
3.6 HYPOTHESIS AND EMPIRICAL MODEL ------------------------------------------------------- 24
3.7 SUMMARY ---------------------------------------------------------------------------------------------- 29
CHAPTER 4: EMPIRICAL RESULTS OF THE RESEARCH ---------------------------------- 30
4.1 INTRODUCTION --------------------------------------------------------------------------------------- 30
4.2 CHARACTERISTICS OF RESEARCH SAMPLES ----------------------------------------------- 30
4.3 DESCRIPTIVE STATISTICS ------------------------------------------------------------------------- 31
4.4 QUANTILE ANALYSIS ------------------------------------------------------------------------------- 39
4.5 REGRESSION ANALYSIS --------------------------------------------------------------------------- 43
4.5.1 Model 1: The firm performance model ------------------------------------------------------------- 43
4.5.1.1 ROE as Firm Performance proxy ---------------------------------------------------------------- 43
4.5.1.2 EB as Firm Performance proxy ------------------------------------------------------------------- 50
4.5.2 Model 2: The Market to Book model --------------------------------------------------------------- 56
CHAPTER 5: CONCLUSIONS, RECOMMENDATIONS AND LIMITATIONS ----------- 60
5.1 INTRODUCTION --------------------------------------------------------------------------------------- 60
5.2 CONCLUSIONS ---------------------------------------------------------------------------------------- 60
5.3 RECOMMENDATIONS ------------------------------------------------------------------------------- 62
5.4 LIMITATIONS ------------------------------------------------------------------------------------------ 62
REFERENCES
GLOSSARY

APPENDIX A
APPENDIX B

iii


LIST OF FIGURES
Figure 1: Distribution of Sectors ------------------------------------------------------------------------ 31
Figure 2: Distribution of Market to Book and Leverage ratios ----------------------------------- 38

iv


LIST OF TABLES
Table 1: Mid-cap property and casualty companies evaluation ----------------------------- 3
Table 2: Summary of Statistics of Market to Book of other Countries in 2010 --------- 11
Table 3: Summary of Statistics of Return on equity of other Countries in 2010 --------- 11
Table 4: Summary of Variables for model ------------------------------------------------------ 24
Table 5: Summary of Statistics and Correlation of the Variables for Year 2009--------- 31
Table 6: Summary of Statistics and Correlation of the Variables for Year 2010--------- 33
Table 7: Classification by ROE in 2009 --------------------------------------------------------- 39
Table 8: Classification ROE in 2010 -------------------------------------------------------------- 40
Table 9: Classification by EB in 2009 ------------------------------------------------------------ 40
Table 10: Classification by EB in 2010 ----------------------------------------------------------- 40
Table 11: t-test for Two-Sample Assuming Unequal Variances ----------------------------- 42
Table 12: Estimate results using ROE and LTDTA in 2009 --------------------------------- 43
Table 13: Estimate results using ROE and LTDTE in 2009 ---------------------------------- 44
Table 14: Estimate results using ROE and TDTE in 2009------------------------------------ 45
Table 15: Estimate results using ROE and LTDTA in 2010 --------------------------------- 45
Table 16: Estimate results using ROE and LTDTE in 2010---------------------------------- 46

Table 17: Estimate results using ROE and TDTE in 2010------------------------------------ 47
Table 18: Estimate results using EB and LTDTA in 2009 ------------------------------------ 50
Table 19: Estimate results using EB and LTDTE in 2009 ------------------------------------ 50
Table 20: Estimate results using EB and TDTE in 2009 -------------------------------------- 51
Table 21: Estimate results using EB and LTDTA in 2010 ------------------------------------ 52
Table 22: Estimate results using EB and LTDTE in 2010 ------------------------------------ 52
Table 23: Estimate results using EB and TDTE in 2010 -------------------------------------- 53
Table 24: Estimate results for market to book using ROE ---------------------------------- 56
Table 25: Estimate results for market to book using EB ------------------------------------- 57
Table 26: Estimate results using EB excluding two dummy variables --------------------- 58
Table 27: Summary of empirical results -------------------------------------------------------- 60

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Market to Book and Firm Performance

CHAPTER 1 : INTRODUCTION
1.1 BACKGROUND
The theory of the capital structure is important framework for studies of
the correlation between capital structure and firm performance. It suggests that
in the determined target ratio, firm„s performance has positive correlation with
debt financing ratio and reduce agency cost. In contrast, when the debt ratio
exceeds a certain level, firm‟s performance has negative correlation with
leverage ratio due to that fact that benefits from the increase in borrowing less
than the increase in agency cost. Tran (2008) tested the relationship between
capital structure and firm performance by using data sample of 50 non-financial
companies in Ho Chi Minh Stock Exchange. The results show that firm
performance has negative correlation with capital structure when debt to equity
ratio is more than 1.812; firm performance has positive correlation with capital

structure when debt to equity ratio is less than 1.812. As stated that the MM
theory1 is an important part in firm‟s financing policy. In addition, tradeoff
theory2 and costly external financing theory3 focus on a relation that price to
book ratio plays in making financing decisions. Therefore, the effect of price to
book on firm performance is the focus of this thesis.

Damodaran (2002) provides evidence that the most important determinant
of price to book value is return on equity, and investors should focus on the
mismatch between return on equity and price to book. Block (1995) argues that
there is a good linear between price to book value ratio and earning to book
value ratio (a proxy of profitability). Xu et al (2005) argue that growth
opportunity has strong relation to firm‟s performance, which is measured by
return on equity (ROE).
1


Market to Book and Firm Performance

There is a lack of empirical evidence on a relationship between market
price to book value ratio and firm performance for Vietnam. Accordingly, the
first objective of this study is to examine possible correlation between firm‟s
performance and market to book value. Tran (2008) finds an insignificant
correlation between growth opportunity and firm‟s performance for 50 nonfinancial companies in Ho Chi Minh Stock Exchange in September 2008. Thus,
the second objective of this study is to examine the effect of growth
opportunity, which is measured by market to book ratio, on firm‟s performance.

1.2 RATIONALE

This study contributes to literature in two directions: (1) by using
ordinary least square regression model and quantile analysis to investigate the

relationship between firm‟s performance and market to book; (2) by using
different measure of firm‟s performance such as earning to book to investigate
the impact of market to book on firm‟s performance to complement one more
measure to return on equity ROE, return on asset ROA, tobin‟s Q of previous
studies in Vietnam. This study also finds a strong relationship between market
to book and firm performance.

In practice, the mismatch between the market to book and firm
performance proxied by return on equity (ROE) provides investors the market
to book comparables approach. The example as bellows shows the market to
book comparables approach.

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Market to Book and Firm Performance

Table 1 : Mid-cap property and casualty companies evaluation
Price to book value
Five

Year

Current

year

Forcasted
ROE

Beta

1996

1997

1998

1999

2000

average

AFC

1.0

1.1

1.4

1.4

1.6

1.3

0.8

9.5%

1.10

AFG

1.5

1.5

1.6

1.2

1.0

1.4

1.0

13.5%

0.95

SAFC

1.2

1.2

1.1

0.8

0.9

1.0

1.1

10%

1.05

ORI

1.4

1.6

1.4

0.6

1.6

1.3

1.2

11%

0.90

2.2

11%

Industry

(Source: Morningstar; The Value Line Investment Survey for ROE forecasts).

As the table 1 shows, ORI is selling at PB of 1.2, which is 55 percent of the
industry mean. The current market to book of ORI is lower than market to book
of previous years, and lower than five year average of 1.3. Forcasted return on
equity of ORI equals industry mean, and higher than the other firms such as
SAFC, AFC. Beta is lower than the others. Therefore, ORI is relatively
undervalued with SAFC and AFC.

AFG is selling at PB of 1.0, which is 45 percent of the industry mean. The
current market to book of AFG is lower than market to book of previous years,
and lower than five year average of 1.4. Forcasted return on equity of AFG is
higher than the industry mean, and highest in all firms. Beta is lower than the
others such as SAFC, AFC. Therefore, AFG is relatively undervalued with
SAFC and AFC.

3


Market to Book and Firm Performance

When comparing AFG to ORI, market to book of AFG is lower than one of ORI
by 0.2, a higher forcasted ROE than ORI, only a 0.05 higher than ORI in beta.
So, we conclude that AFG is relatively undervalued with ORI, and we should
choose AFG for investment.

For managers, they may consider market to book as a proxy of growth
opportunity to improve their firm‟s performance. Firms with high growth
opportunity have more chance to access cheap equity; accordingly, reduce
leverage ratios to maximize profit. From viewpoints of investors, they tend to
favor high growth companies and they are willing to finance firms‟ profitable
projects. In addition, if a company has a high leverage ratio, investors incline to
reduce their investment to firm‟s project because benefits to creditors exceed
benefits to investors. Because of high growth opportunity, companies attract to
sources of funds should gradually reduce its reliance on debt and reduce
leverage. When keeping lower current target ratios, they easily take advantages
of arising future opportunities and have a good firm performance. For instance,
Ho Chi Minh City Infrastructure Investment Joint Stock Company (stock code:
CII) has successfully issued 40 million convertible bonds with a 5 year term for
Goldman Sachs. Why does Goldman Sachs invest in a firm in Vietnam such as
CII? Firstly, the construction industry in Vietnam has high potential to grow
associated with the urbanization rate. Issues of infrastructure and urbanization
are the challenges for Vietnam. More than ever, to attract and to promote the
efficiency of all resources in society, Vietnam needs to invest huge amounts of
capital into this sector, while the ODA loans are decreasing. Therefore,
developing internal resources, efficient use of indirectly invested resources in
the form of BOT (build-operate-transfer), BOO (build-operate-own) is
encouraged more than ever. Secondly, CII is a leading enterprise in the field of
4

Market to Book and Firm Performance

investment and development in infrastructure. Despite of good growth rate and
high profitability, CII still has been evaluated as an infrastructure company with
moderate level of sales, profit and potential growth. Transparency of CII
demonstrated in efficiently managing toll booths to minimize loss of money,
which is the problem in the field of infrastructure. CII efficiently manages risk
by investing in projects that meet the affordability of

most people. Each

subsidiary with its projects must exist based on financial independence. The
company also minimize the negative impacts of interest rate factors and
inflation factors on the projects as well as effective cost management. CII also
demonstrates efficiency in clever combination between the safe investments
(toll booths, water treatment) and speculative invesments (financial investments,
real estate investments) and invests mobilized capital in profitable projects. In
short, five elements which are highly potential growth of industry,
undervaluation, transparency, efficient risk management and efficiency attract
Goldman Sachs in making investment decision into CII. Consequently, CII
gradually reduced reliance on bank loans and have chance to access future
opportunities. With the reputation of Goldman Sachs, some foreign banks have
offered loans to CII for operating activities with interest rate approximately 3%.
This cooperation is expected to give this company opportunities to access other
sources of investment capital on the world financial markets and to strengthen
ability to access important infrastructure projects in Vietnam later. In short, a
firm with high growth opportunity will have high firm performance from cheap
sources of capital. This also helps gradually reduce its reliance on bank loans
and reduce bankruptcy cost (leverage) to attract investors. This also implies that

a firm with good performance during the given period could take advantage of
future opportunities.

5


Market to Book and Firm Performance

In summary, this study provides implications for investors regarding the
relationship between market to book and firm‟s performance. For managers,
they may consider market to book value as a proxy of growth opportunity to
improve their firm‟s performance.

1.3 RESEARCH PROBLEMS

There is a lack of empirical evidence on the relationship between market
price to book value ratio and firm performance. Tran (2008) tested the
relationship between capital structure and firm performance by using data
sample of 50 non-financial companies in Ho Chi Minh Stock Exchange in
September 2008. The results showed that there was an insignificant correlation
between growth opportunity and firm performance, which was measured by
average of return on assets and return on equity. The author did not use the price
to book value as a proxy of growth opportunity, and used growth of total assets
as a proxy of growth opportunity.

Block (1995) used a sample of 30 Dow-Jones Industrial Average stocks
from 1949 to 1962 to investigate the price to book relationship. The author used
scatter graph to show that there was a good linear between price to book value
ratio and earning to book value ratio. Damodaran (2002) used the
COMPUSTAT database from 1987 to 1991 to investigate the price to book

value relationship. The author used quantitative regression analysis with cross
sectional data for each year to show that the most important determinant of price

6


Market to Book and Firm Performance

to book value was return on equity. In Vietnam, there is no empirical evidence
related to the effect of price to book value on firm performance.

Therefore, the problem to be addressed in this study focus on the effect
of price to book value, which is a proxy of growth opportunity, together with
leverage ratio and firm size on firm performance, which is measured by
earnings to book value and return on equity of listed firms in Ho Chi Minh
Stock Exchange and Ha Noi Stock Exchange. The effect of firm performance,
which is measured by return on equity and earnings to book value, combined
with beta on price to book value is the supplement of this study.

Research questions:
 What is the effect of market-to-book on firm performance for firms
listed on Hose and Hnx?
 Whether or not previous firm performance does effect firm (future)
growth opportunities?

1.4 RESEARCH OBJECTIVE

In dealing with the research problem mentioned previously, this study has
the following objectives:

7


Market to Book and Firm Performance

 Based on Xu et al (2005), Frank et al (2005), Titan & Zeitun (2007),
this study determines the effect of market to book on firm
performance after controlling for firm size (ln(sales)), firm leverage
(long-term debt-to-total debt, long-term debt to total assets, total debt
to total equity).
 Based on Damodaran (2002), Block (1995), this study determines if
lagged firm earnings (earnings-to-book value, ROE) on firm growth
opportunities (proxied by market-to-book) after controlling for firm
risk (beta).

1.5 RESEARCH METHODOLOGY AND SCOPE

The study collects 70 samples, which are listed companies in Ho Chi
Minh Stock Exchange and Ha Noi Stock Exchange in the year 2009 and the
year 2010.

Quantitative research method based on ordinary least square regression
and quantile analysis to test hypotheses relative to the relationship between
firm‟s performance and growth opportunity. Models were used in the previous
studies of Tian & Zeitun (2007), Margaritis & Psillaki (2007), Rajan and
Zingales (1995), Damodaran (2002).

This study also uses data analysis tools such as descriptive statistics,
multiple regression conducted by eview 6 for window and quantile analysis
with t-test for difference of population means performed by excel.

8


Market to Book and Firm Performance

1.6 STRUCTURE OF THE STUDY

Chapter 1 presents research background of the study, rationale, research
problems, research objectives, research methodology and scope and structure of
the study.

Chapter 2 includes the topic of cashflow into emerging markets and the
literature reviews which focus on market to book value and firm‟s performance.

Chapter 3 presents data, research method, research sample, variables used in
models, hypothesis and emperical model in the study.

Chapter 4 details the characteristics of research samples, descriptive statistics
and the results of regression analysis of this study. The characteristics of
research samples decribes density of each sector in total samples. Descriptive
statistic method provides the feature of variables such as the sample means,
medians, maximums, minimums, standard deviations as well as the correlation
among variables. The author also compares statistics of market to book ratios,
return on equities between collected firms in this study to other countries.
Quantile analysis is used to diagnose the relationship between the firm
performance and the explanatory variables. Regression analysis method
provides the results of the relationship between market to book ratio and firm‟s
performance of listed companies in Ho Chi Minh Stock Exchange and Ha Noi
Stock Exchange.

Chapter 5 presents conclusions, recommendations, the limitations of this study.

9


Market to Book and Firm Performance

CHAPTER 2: LITERATURE REVIEW
2.1 INTRODUCTION
Chapter 2 includes the topic of cashflow into emerging markets and the
literature reviews which focus on market to book value and firm‟s performance.
2.2 CASHFLOW INTO EMERGING MARKETS

In 2010, Robin Brooks, a senior specialist of foreign exchange strategy
and an editor of a new report, said capital flowing into emerging markets was
575 billion dollars per year, higher than ever and reached 20% higher than
average level at the moment in which the financial crisis of the world had
happened. EPFR Global, a research firm in Massachusetts, announced that the
stock companies of all emerging markets attracted an amount worth 3.8 billion
dollars in week ending on October 20th. Investors invested $ 1.4 billion in bond
funds of emerging markets and withdraw money from stock funds in Japan for
16 consecutive weeks. U.S. stock market also lost $ 1.9 billion. Total amount of
money flowing into stock funds in emerging markets exceeded the record of
44.2 billion dollars in 2009. The causes are: firstly, U.S. dollar relatively weaker
than other currencies make money flow into emerging markets; secondly,
policies in purpose of maintaining low interest rates in the developed countries
encourage investors to seek higher returns in faster growing markets; thirdly,
basic investments in developed countries has remained modest growth, this has
promoted investors to invest money into emerging markets for higher returns.

Regarding to this case, Goldman claims that the amount of capital flowing into
emerging markets will provide the cheap sources of capital, lower yields and
boost domestic demand, at the same time, push up value of currencies and
create pressure on inflation that causes a number of countries will apply the
10


Market to Book and Firm Performance

policies to control foreign investment funds. This implies that higher market to
book value and lower return on equity make stock market of developed
countries less attractive to investors than stock market in emerging countries.
We can see descriptive statistics as bellows.

Table 2: Summary of Statistics of Market to Book value of other Countries in 2010
Mean
Median
Maximum
Minimum
Std. Dev.
Ob.

UK

FRANCE

ITALY

GERMANY

CANADA

JAPAN

CHINA

USA

3.52
1.53
263.64
0.07
12.13
1083

2.59
1.28
233.36
0.09
11.27
541

1.86
1.11
61.07
0.13
4.13
241

2.02

1.43
56.63
0.12
2.97
543

9.92
1.71
3727.45
0.08
108.23
1793

1.46
0.71
1158.07
0.02
19.65
3605

6.51
3.15
2365.74
0.03
46.27
3135

3.81
1.51
1294.00

0.00
21.78
5399

Note: PB = market price / book value per share.
Source: />
Table 3: Summary of Statistics of Return on equity of other Countries in 2010
UK

FRANCE

ITALY

GERMANY

CANADA

USA

JAPAN

CHINA

Mean
Median

0.05
0.01

-0.06

0.04

-0.19
0.02

-0.03
0.02

-0.85
-0.12

-0.52
0.06

-0.07
0.01

0.01
0.05

Maximum

61.84

3.24

0.79

3.44

2.14

19.00

7.26

11.92

Minimum
Obs.

-18.80
1071

-12.42
563

-30.36
251

-3.29
554

-610.55
1771

-376.00
5380

-19.65

3590

-27.99
2881

Note: ROE = net income / total equity.
Source: />
This also gives out a question how companies in emerging markets can take
advantages of these opportunities above, especially firms in Vietnam. This
study just focus on firms with high growth opportunity have good performance
and have more chance to access cheap equity; accordingly, reduce leverage
ratios to attract investors.

11


Market to Book and Firm Performance

2.3 PRICE TO BOOK VALUE
Price-to-book ratio (PB), calculated by dividing the current common
stock price by book value of a firm per share, shows how investors value the
price of common stock in relation to a company‟s book value. In general, PB
ratio indicates investor expectation of the company‟s potential to grow: a high
PB ratio means that investors believe the firm has the high potential to grow,
while a low PB ratio suggests that investors have little expectation of a firm
growing.

According to Gordon (1962), the price to book value is a positive
function of return on equity, the payout ratio and the growth rate, negative
function of the riskiness of the firm. Harris and Marston (1994) used

quantitative regression of book to market (the inverse of price to book) against
variables for growth and risk (beta) for the large sample of companies over the
period July 1982 to the period December 1989. The results showed that
expected growth is negatively related to book value to market, accordingly,
positively related to price to book value. Risk is positively related to book value
to market and thus negatively related to price to book value. Fairfield (1994)
also found that price to book value is related to return on equity. Xu et al (2005)
also shows that there is a strong positive correlation between growth
opportunity and return on equity (ROE).

Damodaran (2002) uses the COMPUSTAT database from 1987 to 1991
to investigate the price to book relationship. The author uses quantitative
regression analysis with cross sectional data for each year to show that the most
important determinant of price to book value is return on equity. The author also
12


Market to Book and Firm Performance

demonstrates that the price to book value is determinded by its expected payout
ratio, its expected growth rate in earnings and its riskiness. An interesting
finding is the mismatch between return on equity and price to book value. It
means that stocks, which have high price to book value and low return on
equity, are overvalued and the others, which have low price to book value and
high return on equity, are undervalued.
The tradeoff theory argues that a firm with a higher market to book ratio
expect to replace debt financing with equity financing on a net basis for their
new investment opportunities because this replacement adjusts the target ratio in
a downward trend. In contrast, the costly external financing cost theory argues
that a firm with a higher market to book ratio favours equity issuance because it

faces relatively lower costs of external equity financing. Hovakimian, Opler,
and Titman (2001) also shows that firms with higher market-to-book ratios have
higher growth opportunities. A study by Long and Zhao (2004) provides strong
evidence that the roles of the market-to-book ratio in making financing decision
are consistent with costly external financing theory rather than the tradeoff
theory. In particular, firms with high market-to-book ratios are significantly
more likely to access the external markets, including issuing equity only, debt
only, or both. Therefore, the relationship between market to book and financing
decision is still a controversial issue in finance largely and the price to book
ratio could be a proxy of growth opportunity. Furthermore, the costly external
financing theory predicts that if higher growth opportunities are not fully
obtained by higher market-to-book ratios, firms with higher growth
opportunities but relatively lower market-to-book ratios may not necessarily
resort to external equity financing; they may even prefer debt financing.

13


Market to Book and Firm Performance

Myers (1977) argues that firms with high growth opportunities tend to
raise funds by equity in order to reduce agency costs and the target ratios.
Myers (1977) also states that firms with high future growth opportunities should
use more equity financing because a higher levered company is more likely to
pass up profitable investment opportunities. Rajan and Zingales (1995, p. 1455)
use market to book value as a proxy for growth opportunity also agree that:
“The theory predicts that firms with high market-to-book ratios have higher
costs of financial distress, which is why we expect a negative correlation”. In
contrast, the pecking order theory suggests that high growth firms should
borrow more because of greater needs for funds.

2.4 FIRM PERFORMANCE

Previous studies used different measures of firm performance to test
hypotheses. These measures included financial ratios from balance sheet and
income statements4; stock market returns and their volatility5; and tobin‟s q6,
which mixes market values with accounting values; profit efficiency7, which is
superior to cost efficiency for evaluating the performance of managers; current
profitability8; earning per share, PE9.

Firm performace may also affect the price to book ratio. A study
Damodaran (2002) provides evidence that the most important determinant of
price to book value is return on equity. Another study by Block (1995) also
shows that there is a good linear between price to book value ratio and earning
to book value ratio. According to Block (1995) earning to book ratio ( a proxy
of profitability) may influence to price to book ratio. The result shows that price
to book ratio is earning to book ratio multiplied by price to earning ratio.
14


Market to Book and Firm Performance

Tran (2008) finds that firm performance has negative correlation with
capital structure when debt to equity ratio is more than 1.812; firm performance
has positive correlation with capital structure when debt to equity ratio is less
than 1.812. Therefore, firms could use debts to improve firm performance when
debt to equity is less than 1.812.

Titan & Zeitun (2007) find that firm size has a positively and
significantly effect on firm‟s performance such as ROA, PROF and Tobin‟s Q.

Pulak Mishra et al (2010) apply panel data estimation techniques for a set
of 52 listed drugs and pharmaceutical companies in India over the period from
2000-01 to 2007-08 to investigate the relationship between mergers,
acquisitions (MA) and firms‟ performance. The results of this study show that
the profitability of a firm depends directly on its size, selling effort and export
and import intensity but inversely on its market share and demand for the
product; MA has insignificant impact on profitability of a firm in long run; inhouse R&D and foreign technology purchase also do not have any significant
impact on profitability of a firm.

Abdel Shahid (2003) uses regression analysis for a sample of 90 most
actively listed companies on Cairo & Alexandria Stock Exchanges (CASE) as
of end of 2000 to explore the effect of ownership structure on firm value. The
results of this study indicate that the dispersed ownership percentage influences
certain dimensions of accounting performance indicators (i.e. ROA and ROE)
but not stock market performance indicators (i.e. P/E and P/BV ratios).

15


Market to Book and Firm Performance

Harold Demsetz, Kenneth Lehn (1985) use a sample of 511 firms from
major sectors of the U.S. economy, including regulated utilities and financial
institutions and a sub sample of 406 manufacturing and mining firms during the
period 1976-80. This study uses ordinary least squares (OLS) regression
estimates to investigate causes and effects of the structure of corporate
ownership. The results of this study find that the structure of corporate
ownership varies systematically in ways that are consistent with value
maximization, which contrast with Berle-Means thesis, as no significant

relationship is found between ownership concentration and accounting profit
rates.

Gorton & Rosen (1995) use quarterly observations of commercial banks
from the second quarter of 1985 until the first quarter of 1990 to find that swaps
are very profitable for dealer banks which may mitigate the incentives for large
banks with entrenched managements to take on risk.

Mehran (1995) uses 153 randomly-selected manufacturing firms in 1979–
1980 to examine the executive compensation structure, ownership, and firm
performance. The results show that firm performance is positively related to the
percentage of equity held by managers and to the percentage of their
compensation that is equity-based.

16


Market to Book and Firm Performance

CHAPTER 3: RESEARCH METHOD

3.1 INTRODUCTION

Following two previous chapters, this chapter presents data, research method,
research sample, variables used in models, hypothesis and emperical model in
the study.

3.2 DATA

This study exploits the accounting and market data of 70 listed companies in Ho

Chi Minh Stock Exchange and Ha Noi Stock Exchange in the year 2009 and the
year 2010. The data set is collected from financial statements on the websites:
and />
The author collected accounting data from annual audited balance sheets and
annual audited income statements of 70 listed firms. Market price to book value
ratio calculated at the end of 2009 and 2010. Beta calculated by using excel
based on the database of daily closed price of Amibroker sofware.
However, the problem is that the database has not enough daily data of stock
price. Therefore the author collected beta from website cafef because
calculation method of this website for beta based on

the CAPM model

( />
3.3 RESEARCH METHOD

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Market to Book and Firm Performance

This study uses quatitative research method based on ordinary least square
regression model and quantile analysis to estimate the relationship between
firm‟s performance and growth opportunity, which is measured by market to
book ratio.

3.4 RESEARCH SAMPLE

Saving time and money is the main cause of the sample used to answer
research questions on the population. This study focuses on all non-financial

firms. If removing

the financial sector, three sectors which have large

proportion on the market are consumer goods, basic merials, industrials.
According to simple random sample, each element of the population has an
equal probability of being selected

to the sample. Assuming that market

(population) includes only three sectors: Consumer goods, basic merials,
industrials, the sample consists of three elements (food, metal, transportation).
Based on collection criteria that the company has good performance during the
period 2009 and the period 2010, the author chooses firms with good
performance in each of three industries.

At the beginning of 673 observations including 289 firms in Ho Chi Minh
Stock Exchange (HOSE) and 384 firms in Ha Noi Stock Exchange (HNX), the
author excludes all firms in financial sector including industries: real estate,
nonlife insurance, general financial, banks, life insurance. The author chooses
three sectors: basic materials, consumer goods and industrials because of a large
number of companies in three sectors besides financial sector. In each sector,
the author chooses one industry: food producers in consumer goods,
18