Luận văn thạc sỹ quốc tế impact of capital structure FULL DISSERTATION (1)

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Student ID:
77182404
Level of Study:
Master
Module Title:
Dissertation
Course Title:
MSCF2016
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Do Thi Phi Hoai
Student Name:
Tang Duc Tu
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21 September 2017
18.997 (excluding table of contents, reference list)

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1


DISSERTATION ON
THE IMPACT OF CAPITAL STRUCTURE ON FIRM
PERFORMANCE
BY
TANG DUC TU
ID: 77182404

21 september, 2017
2


ABSTRACT
Capital Structure is regard as the decision made for funding activities, which
encompass both elements of debt and equity for funding the assets. Whether
financial structure affect the firm’s operation is still under investigation due to
divergences in different academic frameworks. This paper adapts prior studies to
look at Vietnamese case, even though there were many inconsistencies in the
outcomes and the conclusions might be confusing. The case study will examine
selected firms in Vietnam in 10-year period (2007 – 2016) using OLS, Random and
Fixed Effects regression model to test the theories and variables such as debt ratio
from both long and short term, so on and so forth.
It is concluded that it is relevant to say that financial structures affect performance

of a business. This paper shed light on how authorities can build a policy on market
security when debt funding made the market instable. They should revise restriction
policy as well as encourage business to raise long-term investment, which can be a
positive influence on the financial structure of a firm.

ACKNOWLEDGEMENT

I wish to express my gratitude to my kind, generous instructor for always give me
the guidance I need and treat me with patience.
Thanks all my friends and colleagues who accompanied me through this journey,
and give me their sincere advice.
Last but not least, my family who love my dearly and put up with me throughout
this process. I am internally grateful for your support.

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Contents

4


LIST OF TABLES
Table 4.1 Definition of detail number
Table 4.2 Pearson Correlation Matrix
Table 4.3 Result of Hypothesis 1
Table 4.4 Result of Hypothesis 2
Table 4.5 Results of Hypothesis 3
Table 4.6 Regression results of ROA and capital structure
Table 4.7 Regression results of ROE and Capital structure

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CHAPTER ONE: INTRODUCTION

1.1 Background of the research

Financial structure can be defined as monetary choice embraced by a company in
subsidizing its joint speculation. This involves the mix of arrears and financial
ownership to back company's resources. The characteristic dangers in industry
context have added to each allied association cooperating its monetary choice
towards accomplishing ultimate goal. Abu-Rub (2012) argues that capital choice
alters as indicated by the scale of danger identified with each financing alternatives
and in addition the connection amongst deviation and investment revenue.
Businesses try to embrace a combination of capital structure that ensures least cost
to accomplish the chief objective of augmenting association's execution. The effect
of financial structure on operation of a company has been questionable because of
large-scale discussion from differing ways of thinking. Researchers contend mainly
about unrelated and related hypothesis of capital structure. The previous claim that
under extremely prohibitive suppositions of immaculate financial markets, it is not
capitalist' analogous desires, symmetric data and no insolvency cost, money related
formation to decide capabilities of a business. At the same time, the latter which
assume blemished financial markets

have displayed and indisputably uncovered

pessimistic and optimistic main connection between money related structure and
execution of a company (see for instance, Zeitun and Tian, 2007; Onaolapo and
Kajola, 2010; Skopljak and Luo, 2012).

However, according to Modigliani and Miller (1958) any company’s worth in market
has nothing to do with its investment choice is equivalent to the anticipated return
of invested money. Similarly, the standard expense to invest in any business does
not depend on its investment choice and is equivalent to how much pure flow of its
class gets capitalized. The doubtful idea of MM recommendations combined with
their resulting work in 1961 and 1963 activated dubious contentions. This in any
6


case, brought forth the enthusiasm of numerous researchers who took a gander at
differing measurement to investigate the impacts of less prohibitive presumptions
on the connection between finance system and the company’s value (Eriotis, 2007).
Following work of Miller (1977), exhibited another test by pointing that under
specific conditions, the duty shield advantage of loan financing at the firm scale is
precisely off set by the uninspiring expense of obligation from personal income tax.
Modigliani and Miller hypotheses, in any case, accepted that speculators and firms
have same level access to the finance markets, which tolerate with custom made
leverage (Brealey and Myers, 1996). As contended, financial specialists can make
any leverage they needed yet not offered, or the financial specialists can dispose of
any use that the firm went up against yet was not needed. Thus, firms' use choices
don't impact its value (Afrasiobi and Ahemadina, 2011). The supporters (Adelegan,
2007, pratheepkanth, 2011) of Modigliani and Miller hypothesis have given exact
proof that capital structure is irrelevant.
However, given the situation that the flawed financial market has not have its
internal and external fitly alternated, this fact is reflected by the various recent
theories along with their anticipations. Thus, relevance theories recommended that
impact from many elements such as tax, agency, liquidity, market timing, etc.
greatly affect financial choices of action and thusly the firm’s value (Jensen and
Meckling, 1976; Ross, 1977, Leland and Pyle, 1977; Kim et al., 1977; Fama, 1980,

Myers and Mauflis, 1984; Myers, 1984; and Fama and French, 1998). In particular,
these speculations that have been progressed to clarify the finance system
incorporate theory regarding tradeoff, agency costs, pecking order, market timing
neutral hypothesis. According to Kim and Babbel (1995), many body of thought has
started to compromise gradually though many different factors have been deeply
emphasized.
The main issues among the hypotheses can be limited to augmentation of investors'
value. The partition of proprietorship and control in a professionally oversaw firm as
accepted by agency cost framework may bring about administrators applying
inadequate work exertion, enjoying perquisites, picking sources of info or yields that
suit their own inclinations, or generally neglecting to amplify firm value (Jensen and
Meckling, 1976). Thus, the cost for agency of outside proprietorship is covered by
incentive from managers optimizing their own utility, instead of the firm’s value.
7


Many frameworks stated that financial structure may help moderate these agency
expenses. Debt funding is used to control shrewd conduct for individual benefit of
some managers. It decreases the free money streams with the firm by paying
settled premium installments and cores directors to stay away from negative
speculations and work in light of a legitimate concern for investors. In any case, if a
venture yields extensive returns, investors catch a large portion of the pick up. And
in case the venture fizzles, debt holders are to bear the consequences.
Subsequently, investors may profit by betting on business activities that highly
hazardous, regardless of the possibility that they are value-diminishing "asset
substitution effect" as mentioned by Jensen and Meckling (1976). Obviously, when
leverage turns out to be generally high, agency expenses for external debt are high
as well, including higher foreseeable bankruptcy costs or financial adversity costs
which may stem from divergences among bondholders and investors. Similarly,
Nosa and Ose (2010) and Huan and Ritter (2004) as supporters of trade-off theory

stated that firm’s power allocation might be thruster by three opposing factors
namely agency costs, benefits of tax and bankruptcy expenses. Also in Onwumere
et al, (2011), at high power position, investors’ value may not be improved when
prohibitive pledges incorporated into finance obligation assertions restrict the
capacity of firms to optimize its assets. As a result, a business may choose to boosts
its value by excessive utilization of debt. Many prior researchers over the last
decade such as Berger and Patti (2002), Zeitun and Tian

(2007); Ebaid, (2009);

Onaolapo and Kajola (2010); Akbarpour and Aghabeygzadeh (2011); Skopljak and
Luo (2012) have conducted academic researches to shed light on the matter
whether and how financial system how impact on business operation. Bunn and
Young (2004) discussed regarding trade off theory that in deciding on power
allocation, business try to equalize debt benefits and the potential expenses of
financial adversities due to high debt status. On one hand, it is debated by pecking
order theories advocate that company does not aim at optimizing financial system;
but on the other hand, trade-off theory fires back by saying business uses the
minimum resistant and expensive funding mix (Kasoxi and Ngwenya, 2010). Along
these lines, the latter gives no thought to any profit collected from the utilization of
debt against liquidation cost but instead take a gander at obligation as option
because of lacking inner funds. Additionally, the pecking order hypothesis say
leverage proportion to be negatively affects firm’s operation. This relationship has
8


been affirmed in numerous academic researchers in Lemmon and Zender (2008) or
Onaolapo and Kajola (2010). Meanwhile, the former argue that power proportions
are affirmative for firm’s performance which has been affirmed in numerous work as
well (in Sola, 2010; Nosa and Ose, 2010). However, signaling theory expresses that

supervisors have impetuses to utilize different apparatuses to send signs to the
market about the distinction that exist amongst them and other weaker firms. One
of the key instruments to send these signs is the utilization of obligation.
Employment of debt as a financial choice shows that manager has optimistic future
expectation regardless the uninspiring current equity situation. Consequently, the
vast majority of the contentions of relevancy theory are hung on dangers and
returns nature utilizing financial combination available to each company. Generally,
the essential point of decision making in finance by means of equity and debt is to
boost the market value of a firm at lowest possible cost (Khrawish and Khraiwesh,
2008). Thus, use of various levels of obligation and equity in the association's
budgetary

structure

is

one

of

the

firm-particular

techniques

utilized

by

administrators in enhancing its effective execution.
In spite of the fact that, the suspicions of irrelevance hypothesis grounded on the
ideal capital market setting such as no tax nor bankruptcy cost, reasonable
shareholders, fair competition and market productivity. This prompted Modigliani
and Miller (1958) contention that in a universe of certainty in returns, the
qualification amongst obligation and value stores decreases generally to wording. In
this way, regardless of by debt or by equity is the firm established on, market
assessment of any firm bear no effect whatsoever from financial structure. Yet, in
the realm of flawed capital market that exists in our reality, most finance system
might be applicable. The underlining contention of conventional framework of
financial structure is underscored on frictionless nature of MM hypothesis that fills
the hypothesis inadequate. Ross (1977) focuses that if MM hypothesis is finished
and thought to be right, at that point capital structure is vague or arbitrary in fact,
and to some degree restraining premise on which to build up a clarification of
finance structure. One conceivable way to deal with the issue is to adjust the MM
hypothesis to assess the auxiliary highlights of this present reality". Ross (1977)
focused deeper that since intrigue installment on debt are deductible in figuring
corporate wage charge; the value of the firm should ascend with the substitution of
9


debt for profits. Along these lines, high profits could be related with high target debt
proportion, which may emerge for various reasons, for example, possible tax cost
cutting

from

debt

benefits,

less

liquidation

risks

and

conceivably

higher

overinvestment, and different things to break even with (Hovakimian et al., 2004).
The implausible nature of MM hypothesis; and ensuing work by Jensen and Meckling
(1976) in regards to the impact of capital structure on firm execution because of
organization expenses of a firm and different variables has brought forth various
experimental tests as mentioned before. Despite the significance of the vast
majority of the underscored factors, there is changed observational proof on the
effect of finance structure on the operation of a firm in Vietnam. Trial of the agency
theory regularly regression measures of financial system on firm execution markers
and some control factors (Allen and Emilia, 2002). As a result, this will utilize these
measures on panel info regression models to look at the effect of financial structure
on the execution of Vietnamese quoted companies utilizing the latest accessible
information of the firms to fill the research hole.
1.2 Current issues of the research

Different firms have various approaches to access the source of finance. They can
get financial source inside and outside firms. Different choice of funding
mobilization has advantage and drawbacks. The adoption of suitable capital

structure is useful to boost the corporate performance and lessen threats. For
example, decisions of share issuance for capital mobilization can decrease the
leverage ratio and ease the risks related to liability and solvency. By contrast, firms
can govern their business operations without the share of right with other
shareholders. Therefore, the determination of capital structure has the large effect
on the corporate performance for all listed firms, which are attempting to enhance
the business activities.
In the situation of intense competition, firms are trying to strengthen the corporate
performance for profit improvement. Researchers in the earlier studies explored
several factors affecting corporate performance, such as capital structure, firm
culture, and labor. The financial system decision on the performance of a firm has
been making elusive effects due to far-reaching arguments from a variety of
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viewpoints. The existing empirical studies that demonstrate the influence of debt
and equity mix on the performance of each firm in Vietnam is concentrated to
capital structure measurements amidst entrenched conflicting views implicit from
the deviation among their conclusions. Hence, the outcomes and assumptions on
the studies may be ambiguous. As an example, Adelegan (2007) proved negative
however inconsequential correlations between business performance and leverage.
While, Onaolapo and Kajola (2010) conducted a survey on the control of capital
structure on firm performances and stated that capital structure results in adversity
which often time some weighty impact on the operation of a firm. What is more,
Dare and Sola (2010) noted some positive momentous association of leverage ratio
with a firm operation in term of effectiveness in a capital structure related study
with the subject as petroleum industry in Vietnam.
Nonetheless, the agencies of financial structure, including total, long term and short
term debt ratio have a better shot at acquiescing more neutral findings, due to
different practical insinuations regarding different forms of debt instruments. Still, in

nascent debt market which is unusual to Vietnam, most businesses’ peripheral debt
finance is occupied by short term backings, which inflicts the business with even
more excessively costly trouble. For instance, it is believed by Titman and Wessels
(1988) that implementing an altered measurement for leverage ratios as a result of
substantial findings is a good thing since some concepts of financial structure have
different inferences for not agreeing on the constricted classification of leverage
ratios. Likewise, due to the fact that short- term, long- term and total debt obligate
diverse threats and reoccurrence profiles, it would be fascinating to distinguish the
consequences of them (Zuraidah, et al., 2012).
This revelation elevates a significant research question on the efficiency of financial
structure, in complementing effective operation of quoted firms in Vietnam. To
pursue the answer for this issue, this paper hence attempts with different systems
of financial structure to inspect the influence of financial structure on the operation
of Vietnam quoted firms by employing.
1.3 Objective of the Study
The research aims to explore factors affecting corporate performance in Vietnamese
listed firms. The specific objectives are to:
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•
•

Investigate the theories relating to capital structure
Examine determinants of capital structure impacting firm performance in

•

previous studies
Use regression model to analyze the effect of capital structure on firm

•

performance
Discuss the achieved results with other researches

1.4 Research Questions
The researcher proposes the below research questions hinged on the highlighted
specific points in the study
i.

How total debt ratio demonstrates impact on Vietnamese corporate

ii.

performance?
How long term debt ratio demonstrates impact on Vietnamese corporate

iii.

performance?
How short term debt ratio demonstrates impact on Vietnamese corporate
performance?

1.5 Research Hypotheses

The following hypotheses were conveyed as to reach the aims emphasized in the
study:
i.

The impact of total debt ratio on corporate performance is not affirmative

ii.

and substantial.
The impact of long term debt ratio on corporate performance is not

iii.

beneficial and noteworthy.
The impact of short term debt ratio on corporate performance is not
constructively momentous.

1.6 Research’s scope

This examination work secured Vietnamese cited firms that are inside non financial
areas grouping. Henceforth, institutions such as commercial banks, or banking
sectors in general, and insurance agencies, as well as other specific financial
businesses are rejected in the case. The legitimization for this is financial segments

12


are exceptionally controlled; especially the authority’s regulation, which moderately
impact their own financial structure to operation.
This investigation covers ten-year the period (2007-2016). The year 2001 was
picked as the origin year since it was the year banking industry got first hand
experience with universal banking. As bond markets are immature and latent,
commercial banks and other financial business assume a critical part in giving
credits to Vietnamese firms. This period, 2007-2016 additionally witness some

critical policy revisions. Remarkable among the reforms are reviving of Domestic
Debt Market in 2003; Amendment of Companies Income Tax 2007 (Act No.11) or the
famous Personal Income Amendment Act, and so on.
1.7 Significance of the Research

Noticeable financial expert has done observational examination on the importance
and immateriality of financial structure on firm value in various wards. Their
discoveries so far have been essentially substantially relatable to both learning and
improvement. As saw by the analyst, most research in Vietnam are significantly on
the effect of capital structure on the firm execution with limited knowledge of
financial structure. This paper tried to fill the exploration quest in Vietnam by
investigating the effect of financial structure on the operation of Vietnamese quoted
firms. Reliably, this examination will make strong commitment on the academic
framework "financial structure and firm operation". It will likewise uncover firms
financing habits and its effect on the financial execution. To be exact this
examination will have tremendous advantage to the followings:
Economic Analysts
The study can help economist who wants to analyze the inherent characteristics of
debt and equity status of each examined company and also expose the threat of
interest abiding resources. Hence, operators can refrain from inappropriate
practices in financing pattern discovered through the sampled firms.
Stockholders and Businesses

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Stockholders can benefits from the result of this study since it help them be more
aware of the risk in their investments. Also enhance knowledge for companies who
intent to lower price of their idle assets as well as its accompanied risks, hence
avoid instability in profits.

Regulators
Those who may or may not involve in financial factors, this paper offer general
insights, if one needs to expand to this sector.

CHAPTER TWO: LITERATURE REVIEW
2.1 Capital structure theories
Financial structure is combined by two factors: debt and equity capital, which is
decided by the firm administration in the process of bankrolling its corporate assets.
The attempt of financial structure theory in clarifying dissimilarity of corporate
operation, whether relevant or not, has been uncertain as result of a lengthy
clashes of different viewpoints. Among the work of financial structure, some of the
most significant theories are pecking order theory, the static trade-off theory or
agency cost theory, etc. (Brounen et al., 2005). Meyers (1984) even compared the
enigma of capital structure to be trickier than that of profit.

14


According to the work of Modigliani and Miller, in an active market, the sole vital
element that determines a corporate’s market value is the stream of profit produced
by its assets, regardless of any rational stockholders or taxes that hold either strong
or risky debts (Meyers, 2010).
Hence, financial structure has no impact on a quoted firm’s value in the market. The
study, which also assimilates tax in their following findings, makes an argument on
that the value of a quoted firm is a growing function of control resulted from
corporate level costs of interest in tax deduction (Berens and Cuny, 1995 and Hull,
1999).
Habitually holders of quoted firm attain no benefits whatsoever from utilizing taxdeduction debt, rather than equity assets given that so much as personal income
tax and corporate tax are eligible to apply to (Bailey, 2010). Both empirical and
theoretical studies springing from MM theorems have analyzed a variation of capital

effects in connection to leverage such as bankruptcy and agency effects but then
again prevailing divergence still rises among opinions on tax shield advantage in
addition to strength of these effects (Hull, 2007).
Ross (1977) argues that the irrelevance theory adopts the notion of the existing
symmetric information with the hypothesis that there will be no methodical liaison
among financial verdict and corporate value. However, the orthodox approach
assumes that with asymmetric information financial decision can put impact on
evaluating firm’s value (Leland and Pyle, 1977). The authors imply affirmative
statistic even though not one causal connection between debt and value of most
probably analogous projects could be found. Similarly, Jensen and Meckling (1976)
argue that the net effect of the amplifying usage of peripheral debt upsurges the
total agency expenses and upturns prime segment of peripheral debt gained from
the extrinsic equity sale number. Desai et al. (2003) speculates that it is the debt
usage that grows as corporate tax rates increases rather than equity finance.
Consequently, high corporate tax rates can result in greater corporate liability owing
to firm’s need to fully take advantages of the privilege of debt tax shield. Identical
argument was established in Miller (1977) study which implies yearly deviation in
debt percentage mirrored mostly the recurring movement of the economy.

15


On the other hand, trade-off theory demonstrated

that optimal assets structure of

a corporation is a trade-off between utilizing privileges from tax shield and being
charged by bankruptcy costs from retaining peripheral money (debt), keeping
consistency of the corporate is assets and investment plan (Myers, 1984, Bradley et
al., 1984, Zambuto et al., 2011). Henceforth, firms that try to maximize their profit

manage an ideal capital configuration by counterbalancing the corporate tax shield
benefits against personal income, debt-associated cost such as bankruptcy and
agency cost. Meanwhile, corporates that implement striking financial demand do
not plan their debt ratio, because the ordering regulates their select of emergence
of different assets. The amount of asymmetric information decides the comparative
expenses of each source of financial backing. The stricter the asymmetric
information gets, the more uncertain the investment would get, and perpetually the
higher the cost for the security (Octavia and Brown, 2008). The existence of
asymmetric information help corporates in bettering their business by funds acquire
from internal sources rather than external ones.

However, agency theory discusses that the selection of fiscal system can help lower
agency expenses which result from the parting between proprietorship and power.
Agency expenses of external equity can be cut down and firm value can be added
by high leverage ratio through pressuring or reassuring managers to be more
attentive to shareholders’ interest (Berger and Patti, 2002).
Nonetheless, the assumed enticement to the company will favor stockholders at the
outflow of debt-bearers. The modification of leverage ratio to reach incremental rate
may result in high agency budget if not realistically applied. As argued by market
timing theory, timely market-oriented financial structure decision is another realistic
choice to optimally boost assessment. Correspondingly, corporates release equity
when stock values seem to be overrated and purchase again when they are
devalued. In other word, the fluxes of the stock price act as the determining
element to make financial structure decisions.
2.2 Capital structure ratios

16


This section shall review some at academic work regarding financial structure. The

academic materials oppose the notion that leverage ratios are fit to measures of
firms’ financial operation system qualitatively. As a part of firm assets, leverage
ratio is backed with any sort of fixed-charge funding like loan or contracts.
Therefore, leverage is an instrument if the conservatively engaged increase
potential profits of the remaining titleholders. Goldsmith and Lipsey (1963), resist
the assumption that leverage ratio is rather a measure of impending profits than
actual capital ones. Thus, leverage ratio implies the effects of conceivable
deviations in price-pointing out factions that tend to be exposed to, or favored by,
cost changes of several type. Leverage ratio signposts the company's vulnerability
in fulfilling debt service costs. A firm with high leverage ratio tackles a higher
danger of its equity capital being wiped out when unfavorable outcomes from its
risky assets come into existence. Higher leverage ratio also amplifies market risk as
leverage company may be forced to sell properties in order to lower exposure
during marketplace adversity. Therefore, firm that is severely backed by loan
provides creditors with less security in case of liquidation. For instance, if a
business's assets are funded by 75 percentages of loan, in case the assessment
drop down to only 25 percent, creditors’ investments are threatened. In contrast, if
only 25 percent of a company's resources come from debt, property value only
decline to 75 percent before endangering the creditors’ moneys.

Notwithstanding, leverage ratios raise company’s vendors’ concern because of its
impact on the rate of return, in which owners anticipate on to realizing their
speculation and the level of possible risk. Nwude (2003) hypothesize on the
argument that corporate with high leverage ratio might confront bigger fixed-cost
interest rate, plummet in revenue and cash flow is restricted by fiscal leverage lead
to cut-price or even no dividends, ultimately result in reduced share price.
Nonetheless,

this

can

upturn

the

likelihood

of

interest

nonpayment,

thus

accumulating risk of bankruptcy. For short, a company’s leverage ratio essentially
has great impact on potential revenues of the company.

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2.2.1 Total Debt Ratio
Total debt ratio represents a business’ total assets that are funded by peripheral
debt, including both short-term and long-term liabilities. Nwude (2003) opposes
against that these measures only parts of the company’s assets backed by
investors. The higher total debt ratio gets, the company’s fixed-interest expenses
will also rise, ultimately if total debt ratio gets too big, suppose say there were to be
an economic recess, the company will be able to generate consistent flow of cash to
pay for interest. Academic works researching on the impact of debt ratio forecast

that it has positive correlation with scale of investment. For instance, Long and
Malitz (1985) discovered a momentous positive connection between fixed plant and
equipment’s investment scale and the amount of loan. The total debt ratio is
calculated by taking total debt and divides it to the total assets of a company.
Through a significant number of empirical researches, this proxy variable proves to
be the most outstanding measurement of a company’s leverage ratio (Zeitun and
Tian, 2007; Onaolapo and Kajola, 2010; Tze-Sam and Heng, 2011; Kasozi and
Ngwenya, 2010; Baker and Wurgler, 2002; Ju et al., 2004; and Booth et al., 1999;
Khan, 2012; Azhagaiah and Gavoury, 2011).
Total Debt Ratio= (Total Debt)/(Total Assets)

2.2.2 Debt equity ratio

Debt equity ratio, analogous to debt ratio, shows relations between company’s
funded debt and funded equity. This method of evaluating leverage ratio is indeed
not a new one; it is basically debt ratio demonstrated in another way. Debt equity
ratio is used to estimate the measure of total debt to remaining owners’ equity
(Nwude, 2003). Therefore, it shows if the company is more dependent on loan
(debt) or investors wealth (equity) on operations and forming assets. Many
researchers in different prerogatives have utilized this method of evaluating a firm’s
financial structure in their case studies (Zeitun and Tian, 2007; Majumdar and
Chhibber, 1999; Azhagaiah and Gavoury, 2011).
Debt equity ratio= (Total Debt)/(Shareholders’ Funds)
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2.2.3 Long term Debt Ratio

Despite the fact that this formula merge with the previously discusses two
measures, some researchers specifically employ this formula simply because most

interest charges are acquired through long-term loan, and since long-term debt put
on the corporate fixed payment duties for years. Titman and Wessels (1988) argue
that suggestive results are decent proof for implementing other measures of
leverage ratio as well because different financial structure’s concepts have different
suggestions for not grouping all of them as “debt ratio”. Long term debt ratio, which
has been implemented in several case studies (Titman and Wessels, 1988; Zeitun
and Tian, 2007; Tze-Sam and Heng, 2011; Long and Malitz, 1985; Booth et al.,
1999), is measured by having long term debt divided by company’s total assets.

Long Term Debt Ratio =(Long Term Debt)/(Total Assets)

2.2.4 Short term Debt Ratio
Short term debts are loan commitment that generates within one fiscal year. This
aspect is fit to be incorporated in calculating leverage ratio for it appears to be able
to effectively notice when there is incompatibility of funds occurs by a firm. This
may be one main reason why researchers choose to implement a variety of
measurements for leverage ratio instead of narrowing them down. Titman and
Wessels (1988) argue that theories have different pragmatic allegations regarding
to a wide range of loan types. Therefore, mismatching funds happens when short
term debt actually funds long-term investments instead of long term debt.
Seemingly, this result in nonpayment due to interest toll and principal repayment
may collapse due when the earnings (cash inflow) from the venture are not yet
sufficiently generated. The firm may face legal charges due to its inability to fulfill
principal payment. Short term debt ratio, nonetheless, suggests the scale of existing
debts (duties) to alter in a firm’s total assets value. Schinasi (2000) claims leverage

19


is the intensification of either positive or negative return rate on a situation or

investment beyond the rate which is attained by an uninterrupted venture of private
capitals in the marketplace. Theories on financial structures have debated that
short-range debt ratio is a suitable formula to evaluate leverage ratio in shifting
economy with undersized debt market where the majority of most firms’ outward
debt investment is commercial bank debt. Lucey and Zhang (2011) advocate the
view that state-level liberalization of marketplace deducts the practice of long-term
debt, and debt tendency turns to short-term one. Case study by Khan (2012)
disclosed that business in engineering subdivision of Pakistan is mainly reliant on
temporary debt but debts are bound with strong contracts which disturb company’s
operation. Quite a few researchers have engaged their case study with this
measurement (Timan and Wessels, 1988; Zeitun and Tian, 2007; Long and Malitz,
1995; Khan, 2012)
Short Term Debt Ratio= (Short Term Debt)/(Total Assets)
2.3 Firm Performance

The idea of execution in funding activities is a questionable issue to a great extent
because of its multi-dimensional implications. Santos and Brito (2012) sets that the
meaning of firm execution and its estimation keeps on testing researchers because
of its many-sided quality. This hypothetical writing has generated the spirits of
various body of work. Performance assessment are either financial or hierarchical
(Zeitun and Tian, 2007). Refering to crafted by Chakravarthy (1986) and Hoffer and
Sandberg (1987) by Zeitun and Tian (2007) point that financial execution, for
example, value boost, amplifying profits on venture, and augmenting lingering
proprietors value are at the center of the company's viability, while, operational
measures, for example, development in trading and expanding within the industry,
basically accentuates extensive variety of execution as they concentrate on the
elements that particularly result in financial execution. Sanctuary is required to give
data of execution to firm by administration authorities.. And furthermore data
asymmetries amongst administration and other contracting departments urges for
an inner-cycle measurements of firm execution to be accounted for over limited

interims. This in any case, gives wellspring of data to financial specialists and loan
20


bosses on the company's money creating capacity (Dechow, 1994). Financial
articulation is the instrument that passes on data to the clients of financial data.
Market productivity depends on the hypothesis of rivalry in which costs are
aggressively set and choices reflect accessible financial data (Dastgir and Velashani,
2008). Backers of the "all-inclusive concept" contend that far reaching salary
explanation give better measures of firm execution, than other outline pay
measures.

Then

again,

the

individuals

who

advocate

"current

operating

performance" perspective of salary contend that net wage without consideration of
uncommon and non-enrolling things show signs of improvement capacity to mirror

the company's cash streams (Dastgir and Velashani, 2008).
According to Zeitun and Tian (2007), the value of a measure of execution might be
influenced by the target of a firm and securities exchange advancement generally
to the decision of execution measures. Agency cost hypothesis contends that selftarget (interests) of the organization's chiefs and targets of the firm (investors'
value optimization) are not splendidly adjusted (Jensen and Meckling, 1976). The
argument is that administrative offer possession may decrease administrative
incentive to devour perquisites, dispossess investors' wealth or to take part in other
drawback exercises and in this manner helps in adjusting the premiums of directors
and investors and thusly cut down agency expenses and increment firm execution.
In this manner, the merging of intrigue

speculation predicts that bigger

administrative proprietorship stakes should prompt better firm execution.

Contingent upon one's perspective of execution measures, one can take a gander at
a firm and discover it either productively composed or not and that can prompt
better execution. Be that as it may, there are set up hypothetical written works on
the measures (markers) of firm execution, in spite of the fact that these have not
been satisfactorily investigated contrast with different elements in funding. The
most measure that intermediaries firm execution, according to Zeitun and Tian
(2007) and Booth et al. (2009) are to be named: Return on Assets (ROA), Return on
Equity (ROE), Earnings per Share (EPS) as well as overall revenue, or such asReturn
on Investment (ROI), Tobin's Q, P/E, and so forth. The initial four execution measures
featured above simply speak to bookkeeping measures of firm execution in view of
21


chronicled events of the firm to create financial ratios from financial record and
income statements. A few remarkable analysts have utilized these measures in their

experimental examinations (Booth et al., 1999; Zeitun and Tian, 2007; Kajola 2008;
Zeitun, 2009; Onaolapo and Kajola, 2010; Tze-Sam and Heng, 2011; Azhagaiah and
Gavoury, 2011 Skopljak and Luo, 2012; Khan, 2012). Meanwhile, some assortment
of hypothetical written works has set up perspective on the measures of firm
execution.

They

contended

that

instead

of

concentrating

on

bookkeeping

information that is simply historical, a firm execution is better get with the
utilization of market value. The market measures of firm execution are Tobin's Q,
value income proportion, and so forth. Lang and Stulz (1994) fight that the
utilization of Tobin's Q instead of execution after some time, dodge away the issues
of the prior work.
Return on Assets (ROA) is a variable to evaluate a business performance, which
discloses if a company exploits its resources to generate revenue effectively,
through financial statement. High ROA signifies a high effectiveness level of the

business operation. Take a growing ROA for example, it may seem promising at first,
yet would be mediocre if compared with other businesses in the same field.
Therefore, if a firm’s ROA is below average range of the industry, it is not operating
to its optimal potential. Booth et al. (1999) postulates that their case studies utilize
this feature for its being the only measure that can be estimated cross-countries.
They come to term that it is hard to compare profitability country-wise. Other
researchers who also used this variable in their analysis are Zeitun and Tian (2007),
Zeitun (2009), Tze-Sam and Heng (2011), Onaolapo and Kajola (2010) and Khan
(2012). It is safe to say, ROA ratio may be handier in comparison with the risk-free
return rate that to be compensated for the added risk convoluted. If a firm’s ROA is
equal or less than the risk-free rate, sponsors will be disinterested and would rather
just obtain a bond with a secured yield.
ROA= (Profit Before Interest and Tax)/(Total Asset)
2.4 Financial Structure and Firm Performance
There are a lot of researches analyzing the relationship between capital structure
and corporate performance in developed countries. Mwangi, Makau, & Kosimbei
(2014) proved that there exist the positive relationship between capital structure
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and firm performance. Saeedi and Mahmoodi (2011) support the result above that
the correlation of capital structure and corporate performance is positive in Tehran
stock exchange. They also add return on asset (ROA) has significantly positive
relationship with capital structure but return on equity (ROE) has no association.
However, Maina and Kondongo (2013) indicated debt ratio – a part of capital
structure having negative relationship with corporate performance. Javed and
Akhtar (2012) use the regression model to examine the correlation among them,
which support the agency theory. Ebaid (2009) shows the empirical study that
capital structure have insignificant effect on the corporate performance.
In Vietnam, Tristan Nguyen and Huy-Cuong Nguyen (2015) demonstrate that shortterm and long-term debts have the equally negative impact on firm performance.

The impractical postulations and unclear practical proof of the Modigliani and Miller
worth- invariance schemes and inconsistency insignificance in budget of funding
proposals II funded to quite a few case study on capital organization and corporate
operation. Adelegan (2007) discovered that values and leverage put undesirable but
minor influence on each other in collective regression while debt and leverage
correlate in considerably negative way in small-scale sample data. The outcome is
similar to Miller (1977) work stating that individual income taxes on interest
distressing tax savings can cause debt to generate no net tax profit for the
corporate. A case study observing capital system and financial implementation of
some specific firm in Colombo Stock Exchange conducted by Paratheepkanth (2011)
established data on trifling harmful association among capital system and financial
functioning. Another research grounded by previous case study on the effects of
capital system modification to security expenses in America conducted by Masulis
(1980) disclosed that stock price changes have the same qualitative relationship to
announced leverage changes regardless of the direction of the change.
Majumdar and Chhibber (1999) examining Indian’s corporates’ structure and its
financial operation discovered substantial transposed liaison between debt equity
ratio and corporate performance. Some control measures such as size, advertising,
liquidity and diversity were uncovered as positive influence on performance.
Whereas, some variables cause substantially undesirable effect on performance are
namely time, age, exercise and group. Still, the inverse correlation between capital
23


system and corporate performance found may have been the result of Indian
financial market’s high borrowing cost (interest rate) along with that firm with high
leverage ratio is considered as less commercially effective than ones with a higher
equity ratio. The inverse correlations of capital organization and corporate
performance is confirmed through quite a few case study employing panel data
regression assessment (Schiantarelli

and

Sembenelli,

1997;

Ebaid,

2009;

Adelegan, 2007; Zeitun and Tian, 2007; Cheng and Tzeng, 2011; and Onaolapo and
Kajola, 2010; Uremadu and Efobi, 2012; Azhagaiah and Gavoury, 2011; Mubashar et
al., 2012).
Schiantarelli and Sembenelli (1997) attempted to examine a pragmatic causes and
effects of the development system of debt by using panel data companies from the
UK and Italy. In observing how financial system affect firm’s performance in general,
leverage ratio was used as a regression assessment to control, data from Italian firm
shows substantial adversity and noteworthy effect of leverage on a business’
productivity. In other word, being under financial difficulty does necessarily result in
betterment in efficiency. The outcome does not agree with previous academic
agenda that managers are urged to take better decision during financial adversity.
Correspondingly, they claimed that great leverage ratio may also reduce chance to
improve efficiency, since pledgers, comparative stake is minor in the business.
Nevertheless, capital organization’s influence on business’s productivity acquired
from a case study of non-commercial Egyptian quoted companies during eight years
(1997-2005) which employed OLS multiple regression analysis by Ebaid (2009),
exposed that capital organization which evaluated by total debt and short-term debt
consecutively to total assets affects deleteriously on productivity evaluated by
return on asset of a business. Instead, the study showed no noteworthy sign of

capital system’s determining control over productivity evaluated by return on equity
and gross revenue periphery, through the use of short and long term debt and total
debt to total assets. Ebaid (2009) thus comes to the assumptions that overall
capital system in Egypt has very feeble impact financial productivity of quoted
firms.
In another case study on Vietnamese firms by Onaolapo and Kajola (2010), capital
structure measured by debt ratio was uncovered as a substantially undesirable
element to both ROA and ROE - productivity measurement. Researching on the
24


impact of capital organize and cash of business returns in Vietnam by Uremadu and
Efobi (2012), the paper examined 10 manufacturing companies for the period of
four years between 2002 and 2006, employing OLS regression estimate. The
outcome is that high income tax systems along with excessive inflation in
Vietnamese make business unable to optimally generate profit using long term
debts. The researcher postulate that for Vietnamese business, the more long-term
debts ratio grows in comparison to capital equity, the better it will get to generate
revenue.
Also it was claimed that higher ratio short-term debts over total debt as long as
long-term debts over total debt results in the corporate’s inefficiency in generating
profit. The research, yet, assumed that the value of long term debts examined by
log linear analysis can indicates adversity for the firm but the final outcome did not
match with the prediction made prior to that. Therefore, according to the scholar, it
is either Vietnamese corporates assemble insufficient long term debts or there may
have been severe falsifications in the fiscal structure of the economy during the
period of time that was examined.

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