Firm-specific Factors Affecting on cost of equity in Vietnam

FIRM-SPECIFIC FACTORS AFFECTING
COST OF EQUITY IN VIETNAM

HoChiMinh city, Vietnam
2013


TABLE OF CONTENTS

LIST OF TABLES .......................................................................................... iv
LIST OF FIGURES .......................................................................................... v
ABSTRACT .................................................................................................... vi
CHAPTER I: INTRODUCTION ...................................................................... 1
1.1.

Background and motivation of the study .............................................. 1

1.2.

Research Objectives ............................................................................ 3

1.3.

Outline of the study ............................................................................. 4

CHAPTER II: OVERVIEW OF VIETNAM STOCK MARKET....................... 5
CHAPTER III:LITERATURE REVIEW ......................................................... 8
3.1.

Cost of equity and estimation models .................................................. 8

3.1.1. Cost of equity .................................................................................. 8
3.1.2. Cost of equity estimation models ...................................................... 9
3.1.3. Alternative methodology for estimation of cost of equity capital ..... 12
3.2.

Firm-level factors ............................................................................. 13

3.2.1. Beta ............................................................................................... 13
3.2.2. Size ................................................................................................ 14
3.2.3. Debt to Equity ratio (DE) ............................................................... 15
3.2.4. Book to market ratio (BM) ............................................................. 15
3.2.5. Assets turnover ratio ...................................................................... 16
3.2.6. Inventory to total assets .................................................................. 17
CHAPTER IV: DATA & METHODOLOGY ................................................. 18
4.1.

Data .................................................................................................. 18

4.2.

Methodology ..................................................................................... 20

4.2.1. Estimating cost of equity ................................................................ 20
4.2.2. Hypothesis ........................................................................................ 20


4.3.

Econometrics Testing ........................................................................ 21

4.3.1. Multicolinearity Test ..................................................................... 21
4.3.2. Auto-correlation Test ..................................................................... 22
4.3.3. Fixed or Random Effects Model: .................................................... 23
4.3.4. Heteroskedasticity Test : ................................................................ 23
CHAPTER V: EMPIRICAL RESULTS ......................................................... 26
5.1.

Data description ................................................................................ 26

5.2.

Econometric tests .............................................................................. 28

5.2.1. Multicolinearity Test ..................................................................... 28
5.2.2. Auto-correlation Test ..................................................................... 28
5.2.3. Fixed or Random Effect Model ( Hausman Test) ............................ 29
5.2.4. Heteroskedasticity Test .................................................................. 30
5.3.

Empirical Results ............................................................................. 31

5.3.1. Beta and Cost of equity...................................................................... 31
5.3.2. Size and Cost of Equity ..................................................................... 32
5.3.3. Debt to Equity and Cost of equity ..................................................... 32
5.3.4. Book to Market and cost of equity .................................................... 34
5.3.5. Total Asset Turnover and Cost of Equity .......................................... 35
5.3.6. Inventory to Total Asset and Cost of Equity ...................................... 36
CHAPTER VI: CONCLUSION ...................................................................... 37
6.1.

Conclusion ........................................................................................ 37

6.2.

Suggestions for further research ........................................................ 39

6.3.

Research limitation ........................................................................... 39

LIST OF REFERENCES ............................................................................... 41
APPENDIX .................................................................................................... 45


LIST OF TABLES
Table 1 : Hypothesizes ............................................................................................... 21
Table 2: Description Data ......................................................................................... 26
Table 3: Correlation .................................................................................................. 28
Table 4 : Hausman Test ............................................................................................. 29
Table 5: Final Regression Result on firm-specific factors and cost of equity ...... 31


LIST OF FIGURES
Figure 1: The performance of VN-Index and trading volume from 2000-2013 ..... 7
Figure 2 : The research framework. ........................................................................ 25
Figure 3 : Mean of Cost of Equity and Debt to Equity Ratio (2009-2012) ........... 33
Figure 4: Mean of Cost of Equity and Book to Market Ratio (2009-2012) .......... 34


ABSTRACT

This thesis investigates the relationship between specific-factors and the
cost of equity capital in the Vietnam stock market. The approach applied by
Pomerleano and Zhang (1991) has been used to estimate the cost of equity. The
sample consists of 79 listed firms spread across both HoSE and HNX. For a period of
three years, namely, 2009 to 2012 have been collected data to test the relationship
between cost of equity capital and the level of firm-specific factors including market
risk (BETA), the size of company (SIZE), Book to market ratio (BM), Debt to equity
ratio (DE), Asset turnover ratio (ATO), Inventory to total assets (INV). Panel data
and econometric testing model are implemented in the paper in order to get the most
precise results. After running regressions, the final results show that BETA, SIZE,
BM, ATO, INV are positive related to the cost of equity, while DE shows a negative
association. Most coefficients confirm the expected relationship, documented by
previous studies. For exception results between DE, SIZE and cost of equity, the
paper explains basing on some unique characteristics of Vietnam market. Finally,
some conclusions and recommendations for further research are made in order to
capture some limitation of this paper as well as understand deeply these relationships
accompanied by difference of Vietnam stock market.

.


CHAPTER I

INTRODUCTION

1.1.

Background and motivation of the study:
In order to increase the total value of economic unit, it is not only making

the right decisions and selecting the optimal solutions for investment funds but also
estimating accurate cost of capital, which is major issue in the financial literature. A
company's securities typically include both debt and equity, so determining a firm’s
cost of capital requires one to calculate both the cost of debt and the cost of equity.
However, the cost of equity is more challenged to calculate because equity does not
pay a set return to its investors.
The cost of equity is the return that stockholders require for their
investment in a company. There are many reasons to explain why equity cost is
important. Firstly, cost of equity represents to the compensation that the market
demands in exchange for owning the asset and bearing the risk of ownership.
Secondly, the cost requires the company to maintain a share price that is
theoretically satisfactory to investors. Thirdly, it is also a major criterion in
determining the investment priorities and the optimal capital structures. Hence, the
practice of estimating precise equity cost is a necessity.
Eichengreen (2001) suggests that firm-level data should be used to
capture the effects of institutional development on the cost of equity capital. In
Vietnam stock market, the paper conducted by Anh (2012) also presents that there is

1


not only the systematic risk but also the liquidity risk strongly affect the rate of
return, so using CAPM in Vietnam is not stable. To continue this subject, this study
would investigate whether and how some firm-specific variables such as market risk
(BETA), the size of company (SIZE), Book to market ratio (BM), Debt to equity
ratio (DE), Asset turnover ratio (ATO), Inventory to total assets (INV) to impact on
cost of equity in the emerging market, Vietnam is in particular. There have been
conducted relatively large numbers of research about the relationship between firmspecific factors and the cost of equity. And empirical results of the paper’s findings
will make the literature of the subject richer.
In the present, there are many models using for estimating cost of equity:

the capital asset pricing model (CAPM) (Sharpe,1964; Lintner,1965); Dividend
Growth Model (Gordon, 1962); the three-factor model (Fama and French,1993) the
international asset pricing model (IAPM) (Bekaert and Harvey, 1995), and so on.
Each of these models have the effectiveness needed for estimating the cost of equity
capital in one or more specific market in a period of time; and their efficiency is
reduced and replaced with each other over time. Although these different models or
techniques provide estimates of ‘reasonable’ magnitude, the search for a model that
is easy to use and provides accurate and stable estimates over time is not over yet
(Fama and French, 1997; Madanoglu and Olsen, 2005). Moreover, Vietnam is an
emerging market and the stock exchange is too young (established in 2000) with
lack of historical data and consistent accounting standards. Although the above
techniques have been applied successful in developed countries, such limitations
cause some issues when they are used in emerging markets like Vietnam. Instead,
this study introduces an alternative estimation model applied by Pomerleano and
Zhang (1999) to estimate ex-post measures of cost of equity capital at firm-level
based on historical realized returns. The disadvantage of ex-ante measures, the
limitation of the above methods as well as the reasons why using the approach
applied Pomerleano and Zhang (1999) would be considered in the literature review.

2


Vietnam is one of the emerging markets which have small young stock
markets, so Vietnam market has some unique characteristics which influence on the
relationships between cost of equity and firm-specific factors mentioned above. The
question is here whether theories as well as results of previous studies regarding the
relationships are still accurate in Vietnam stock markets or not. For example, the
financial leverage ratio or Debt to Equity (DE) of Vietnamese firms is 1.1x on
average (2009-2012) and higher than mean of the DE in other neighbor markets,
0.98x (Feng et al., 2013); however, investors still believe that whether there is a

negative relationship between cost of equity and Debt to Equity ratio in Vietnam
market. Similarly, such questions are also made to other factors. Hence, the answers
would be in the finding section of this study.
This paper would contribute on the literature as well as the real stock
exchange by several ways. First, the results give clearly understanding cost of equity
related to firm-specific factors for investors to make accurate decisions in Vietnam
stock market. In addition, this paper supports reliable results in conclusions for the
future studies to investigate deeper the relationship between equity costs and factors
in emerging markets in general or Vietnam in particular.
1.2.

Research Objectives:
The purpose of this thesis would be
Indicating whether and how firm-specific factors relate to cost of equity in
Vietnam stock market.
Investigating empirical results compared with arguments of the previous
papers
Recommendations for the future studies regarding the relationship between
cost of equity and firm-specific factors.

3


1.3.

Outline of the study:
The study is laid out as follows.
Chapter

I:

INTRODUCTION briefly mentions

the dissertation

objectives, important contents and methodology conducted in the dissertation.
Chapter II: OVERVIEW OF VIETNAM STOCK MARKET includes
the background, the organization and operation and the main features of Vietnam
stock market index.
Chapter III: LITERATURE REVIEW focuses on the theoretical,
estimating cost of equity models and empirical review of the relationships between
firm-specific factors and cost of equity
Chapter

IV:

DATA

&

METHODOLOGY

describes

the

data

characteristics, the way used for gathering figures of different sources and research
methodology employed in this dissertation. The chapter provides the test process

including econometric assumptions.
Chapter V: EMPIRICAL RESULTS illustrate data, the regression results
of the study, analysis and compare arguments obtained from the empirical tests
Chapter VI: CONCLUSION part summaries the outcome and provides
some limitations and recommendations for further studies

4


CHAPTER II

OVERVIEW OF VIETNAM STOCK MARKET

In order to have an overview of Vietnam stock market, this chapter
provides information including history, development, and some highlight periods.
The government did aware the advantages of open market and
competitive business environment, so the economic reform namely “Doi Moi” was
introduced in 1986. Since early 1990s, an official stock market was established by
Vietnam government with the purpose of creating a more robust market economy.
After four years of delays, the State Securities Commission of Vietnam (SSC) center
was established in 1996 as a remarkable achievement in creating a public security
market. SSC plays an important role as the highest governmental body responsible
for organization and operation regulation of Vietnam securities market. As regards
international aspect, SSC has cooperated with foreign countries and international
financial institutions to complete legal framework and leads Vietnam to an effective
operation capital market. For conducting an appropriate model in Vietnam stock
market, SSC has studied the stock market development of other Asian countries
such as China, Thailand and Taiwan thoroughly. For instance, Vietnam has followed
the rules of foreign investment and ownership of these Asian markets.
As a rule, a developed official trading center of stock market should be

over the operation of an informal or OTC market in advance. However, the practice
did not happen in Vietnam before the announcement of the official stock market in
2000, which is the result of the government’s awareness of its necessity in
developing the capital market in particular and the whole economy in general. In

5


2000, the first official stock exchange market – Security Trading Centre was
launched in Ho Chi Minh City (HOSTC), marking the new stage of Vietnam stock
market development. HOSTC is a non-profit organization under the direct
administration of the State Securities Commissions with the three main functions
which are organizing, managing and operating the securities trading system,
conducting examinations and supervision of the trading activities and performing
and settling the securities transactions. In the first trading days, HOSTC begins with
only two listed companies with a total capitalization of 16.87 million, namely the
Refrigeration Electrical Engineering Joint Stock Company (REE), and Saigon Cable
and Telecommunication Material Joint Stock Company (SACOM). The market’s
growth by number of listed companies so far has been higher. With the purpose of
opening more capital mobilization channels for the government as well as
supporting the relationship between the fiscal policies and the monetary system, in
2005, Hanoi Stock Exchange (HNX) was established and started trading on
14/07/2005. Until now, there are more than 600 listed stocks. Compared with the
other Asian capital markets, Vietnam stock market can be seen as the smallest and
the most illiquid market. Vietnam stock market has considerably low but steady
growth. Recently, Vietnam stock market witnessed the most rapid development in
2006 in terms of listed companies, total capitalization and trading volumes. From the
end of 2006 to the beginning of 2007, VN-Index rapidly increased and hit the peak
in March, 2007.

6


Figure 1: The performance of VN-Index and trading volume from 2000-2013
(Source: hsx.vn)
The figure describes the movement of VN-Index over the past 12 years.
From the established time to 2012, it is worth taking into account that there are two
noticeable periods. In 2000-2005, this is the start-up period and market movement is
unstable. The second period is from 2006 to 2007, a nonstandard return that only
happens once in 60 years (Hua Chia Yee, CFA) did occur with Vietnam stock
market in this period. In general, the VN-Index series has upward trend from the end
of 2002 to the end of 2007. The most rapidly development was seen in 2006 with the
significant increase in number of new listed companies, amount of market
capitalization, VN-Index and trading volumes.
Overall, Vietnam stock market is still young and small with the typical
characteristics of emerging market such as high volatile, illiquidity capital market,
imperfect legal framework and irrationality of investors. However, Vietnam stock
market rapidly develops with huge potential, worthy to comprehensively investigate.
And some oversea theories are not consistent with empirical results in Vietnam, for
example, the relationships between cost of equity and relative factors.

7


CHAPTER III

LITERATURE REVIEW

This chapter reviews the definition of term cost of equity; popular models
used for estimating the cost of equity as well as their disadvantages; introduces the

Pomerleano and Zhang approach and then this chapter also gives reasons why it is
suitable for measuring ex-post cost of equity capital in the paper. The results of
oversea papers regarding the relationships between firm-specific factors and cost of
equity are also considered.
3.1.

Cost of equity and estimation models :
3.1.1. Cost of equity :
The cost of equity capital can be defined as the expected rate of return of

the current and prospective equity shareholders. As a firm becomes riskier, the
investors demand a higher return resulting in a higher cost of equity capital. There
are following main reasons explaining why equity cost is important. Firstly, a firm's
cost of equity represents the compensation demanded by the equity shareholders to
bear the risks associated with the firm which in turn affects stock prices. Second, a
certain return is expected by common shareholders when their equity is invested in a
company. The equity holders' required rate of return is a cost from the company's
perspective because the stock price would be fallen due to simply shareholders’
selling if that company does not deliver this expected return. The cost of equity is
seen as a cost which firms have to maintain a share price in order to gratify
theoretically investors’ requirement. Thirdly, determining the investment priorities
and the optimal capital structure would not be feasible without estimating the cost of
capital rate as well as cost of equity.

8


3.1.2.

Cost of equity estimation models:

Regarding the estimation of the cost of equity capital, there are two
streams in the existing literature, namely ex-ante estimates based on analysts’
forecasts, and ex- post estimates based on historical realized returns (Mónica, 2007).
In addition, Erb et al. (1996a) used sovereign credit rating for calculating cost of
equity capital.

Ex-ante estimates:
The basic idea of the ex-ante cost of capital models is using observable
forward-looking data instead of historical return realizations (Gebhardt, Lee, and
Swaminathan, 2001). The unobservable expected cost of equity capital is estimated
from currently available analysts’ consensus forecasts about a firm’s future income
and its market price (Klein, 2006). Since Ameer (2007) argues that the main
assumption of these studies has been analysts’ forecasts of short-run and long-run
earnings and dividend per share capture market expectations. Moreover, lack of
analysts’ forecast data for sufficiently large numbers of firms in the emerging
markets further exacerbates the choice of firms for meaningful analysis. The analysts
overstate the long-term growth of earnings and dividends and objectivity are still
major issues (Goedhart et al., 2002). Therefore, these ex-ante techniques have
limitations when applied to emerging markets.

Using sovereign credit rating:
Erb et al. (1996a) estimated a time series cross-section regression and the
model forces a linear relation with the negative slope coefficient between credit
rating and expected returns. This implies a higher credit rating associated with lower
average returns. However, he also argues that the model is not necessarily the best
model for expected returns and volatility because of the nature of the problem that
there is no way to verify the accuracy results until some of the developing countries
“emerge” into the databases. In addition, such a method may be not appropriate with

9


the purpose of this paper which conducts specific cost of equity of each firm in a
country, Vietnam.

Ex-post Estimation models:
Beside ex-ante estimates based on analysis’ forecasts in the valuation
model, there are many ex-post measure models found on realized returns and
dividend per share such as the dividend growth model (DGM (Gordon,1962); the
three-factor model (Fama and French,1993); The international asset pricing model
(IAPM) (Bekaert and Harvey,1995) ; Capital Asset Pricing Model or CAPM
(Sharpe,1964; Lintner,1965); and the methods applied by Goedhart et al.(2002) and
Pomerleano and Zhang (1999). The section would overview each model and
emphasize below weakness of each model in order to recommend an alternative
suitable model, the approach applied by Pomerleano and Zhang in 1999.
The Dividend Growth Model was proposed by Gordon in 1962. Changes
in the dividend yield of firms have been used to measure the cost of equity capital at
the country-level (Miller, 1999; Bekaert and Harvey, 2000; Henry, 2000). Ameer
(2007) argues that many firms have moved away from paying cash dividends to
buying back shares. Firms are finding other ways to return cash to shareholders.
Madanoglu and Olsen (2005) argue that another significant issue in applying DGM
lies in determining the specific dividend growth rate. Especially emerging markets,
the estimates of cost of capital based on dividend yield might not be robust (Ameer,
2007).
Fama and French’s (1993) three-factor model is an extension of the
CAPM-type structure. It is a multi-factor model with postulates that factors other
than market and the risk free rate impact stock prices. Although Fama and French
(1997) argue that the three-factor model explains more variation in the equity risk
premium than the original CAPM model, it produces large standard errors.

The international asset pricing model (IAPM) can give negative
estimates of the cost of equity capital, as reported in Daouk et al. (2005) due to its
nonlinear structure which it is mathematically challenging and not easy to use.

10


The Goedhart et al. (2002) method assumes that expected growth in the
firm-level earnings is equal to GDP growth rate plus expected inflation rate.
However, the major limitation of this method is that the assumption of the historical
average of real GDP growth rate as a proxy for long-term corporate profit growth, it
is only accurate for mature firms which have profit growth tracks GDP. While this
paper requires estimations for whole Vietnam stock market including small and big
firms.
Capital Asset Pricing Model or CAPM (Sharpe,1964; Lintner,1965) is
one of the most well-known and accepted models calculating the cost of equity.
CAPM is used to estimate cost of equity. CAPM was built from Harry Markowitz’s
portfolio optimization model. Although CAPM is actually very easy to apply, there
are many barriers and many necessary assumptions when applying CAPM in
Vietnam market.
Firstly, CAPM was based on Markowitz portfolio theory, hence it has a
same assumption, market return must consist of all risky assets of the whole
economy such as stocks; real estate, gold, and so on. Yet, these markets are not
traded with published real information in Vietnam market. As the result, it does not
make sense if we apply CAPM to Vietnam and assume VN-Index as a benchmark
portfolio. It is not accurate to see VN index as representation for whole of the
market because VN Index is not even a half of Vietnam market capitalization (data
of ETF). In addition, individual investors attract not only stock market but also other
investment channels such as currency or gold. Thus, it is hard to have correct beta
value by using the VN Index as a benchmark.

Secondly, VN Index is not able to represent to a liquidity and diversified
market because it is small size and young (officially established since 2000).
Moreover, VN Index annual returns change annually with very high volatility.
Thirdly, Vietnam government bonds do have risk. According to Moody
country risk raking, Vietnam bonds are rated Ba3 which are below investment
bonds. The point of fact is that it is hard for Vietnam government to pay debt. That
means Vietnam government bonds are not suitably seen as risk free assets. Besides,

11


it is not appropriate to make long-term assumption basing on the quality and length
of data on bond. There three following main reasons why the original CAPM might
be expected to fail.
3.1.3. Alternative methodology for estimation of cost of equity capital :
The previous papers investigating cost of equity such as Botosan and
Plumlee (2004); Chen et al.(2004); Hail and Leuz (2006) have used analysts’
forecast data on earnings, dividend per share, return on equity and earnings growth
to estimate ex-ante cost of equity capital, but these techniques have limitations when
applied to emerging markets. Since Ameer (2007) argue that the main assumption of
these studies has been analysts’ forecasts of short-run and long-run earnings and
dividend per share capture market expectations. Moreover, lack of analysts’ forecast
data for sufficiently large numbers of firms in the emerging markets influences
negatively on the choice of firms for meaningful analysis. In his paper, he also
mentions that from theoretical and methodological perspectives, ex post measures of
cost of capital at the firm-level are better than ex post measures at the country-level
obtained from aggregate stock returns using the CAPM, the APM and Fama and
French’s (1997) three factors model. The conclusion supports for the purpose of this
study only wondering cost of equity at the firm-level.
From the limitation of the other methods and the advantages of ex-post

measures mentioned above, this paper would use the approach applied by
Pomerleano and Zhang (1999) to estimate ex-post measures of cost of equity
capital at firm-level. In the research, they began with the relationship between equity
prices and the implied growth of future nominal earnings is derived from the
hypothesis that current equity price, Pt , equals the discounted present value of future
earnings, Et+j , (j ≥ 1), with a discount factor rt.

12


Pomerleano and Zhang (1999) assumed that future earnings grow at a
constant rate, gt, such that Et+j+1= (1+gt) Et+j, equation 1 becomes:

From that the relationship between the current price to earnings ratio
(P/E), the discount factor, and the future earnings growth rate is showed
(3)
The equation (3) is solved for the implied cost of equity:

RE =

(4)

With the above equation (4), Ameer (2007) applied in his research
regarding the relationship between specific-factors and cost of equity, he assumed
that past earnings growth can be used as a rough proxy for future growth. The
method does not require analysts’ forecasts. It is simple and suitable for the
developing countries like Vietnam.
With the purpose of testing the relationship between firm-specific factors
including market risk (Beta) and cost of equity, it is necessary to gain “crystal”
measures cost of equity which use estimation models without following any model

like CAPM, IAPM, and so on. There are two appropriate methods namely Dividend
Growth Model (DGM) and equation (4). However, DGM has some disadvantages
mentioned above, therefore, the approach applied by Pomerleano and Zhang (1999)
with equation (4) would be suitable and used in this paper.
3.2.

Firm-level factors :
3.2.1. Beta:
Beta (β) indicates the sensitivity of the company to market risk factors.

Beta represents the market risk for an asset and is calculated as the statistical
measure of volatility of a specific asset/investment relative to the movement of a
market group. The conventional approach for estimating beta of an investment is a
regression of returns on investment against returns on a market index. According to

13


the capital asset pricing model (CAPM), the cost of equity capital is positively
related to a firm’s beta. In addition, Botosan (1997) and Hail (2002), Sharpe (1964)
find that a firm’s beta is positively associated with its expected stock return.
On the other hand, Chui and Wei (1998) examine the relationship
between expected stock returns and beta (β), book-to-market equity, and size in five
Pacific Basin emerging markets: Hong Kong, Korea, Malaysia, Taiwan, and
Thailand. They find no evidence in supporting a positive relationship between
market beta and stock returns.
3.2.2. Size:
One of the important interpretations in return, risk and asset pricing
literature is Size. There are various ways to measure the size of firm such as annual
revenue, value added, and assets. However, revenue measure tells nothing about the

depth of the underlying activity and value added gives a precise measure of activity,
but it is usually not publicly available for individual firms (Canbäck, Feb. 2002).
Wald (1999); Mackay and Phillips (2002) found that most effective proxy for firm
size is the natural log of total assets. Thus, this paper would calculate Size variable
by nature log of a firm’s total assets and test whether a negative relationship is still
right in Vietnam stock market.
In the finance literature, it has been documented a negative size effect in
the return-risk relationship established by the CAPM (Banz, 1981). Moreover,
Bloomfield and Michaely (2004) argue that large firms are expected to have higher
returns and slightly less risk than small firms. Bowen et al. (2008) indicate that large
companies attract more attention which can reduce the problem of asymmetric
information and lowers the cost of equity capital. A significant negative relationship
between firm size and the cost of equity capital is found by Hail and Leuz, 2006;
Chen et al., 2004. A negative relationship is expected between SIZE and cost of
equity capital.
However, Anh (2012) investigated the relationship size and returns of the
Equities in Vietnam Stock Market. He shows that the size variable can affect the
equity costs of listed shares, the slope coefficient is above 0; which in turn implies

14


that there is the positive correlation between the size and the cost of equity and vice
versa.
3.2.3. Debt to Equity ratio (DE):
It is worth taking into account that Debt issue is significant factor
influencing on firms’ performance in Vietnam market. The Debt-to–Equity ratio
recorded of 647 listed non-financial firms on Quarter II-2012 is quite high with
1.53x in average. Vietnam market is seemed as one of countries which have the
highest DE in the entire world. This issue was warned many years ago, according to

General Statistics Office (GSO, Vietnam) in 1999-2002, the Debt to Equity was
1.32x in 1999 and 1.96x in 2002. Especially in the period from 2007 to the present,
Vietnamese companies have tended to use high financial leverage.
DE is defined as a measure of a company's financial leverage calculated
total debt-to-total market value of equity ratio at the end of year. It is proved that the
ratio relates directly to cost of equity capital of a firm.
The high debt to equity means that debt is used much to finance
increased operations, so the company likely to gain potentially more earnings.
Inversely, it is worth taking into account that shareholders are able to gain nothing
due to bankruptcy. The argument is that the tax benefit of debt diminishes beyond a
certain point, and the additional financial risk outweighs the lower nominal cost of
debt, thereby increasing the cost of equity capital, reflecting the increase in the
financial risk of a firm.
The Modigliani–Miller II theorem argues that a higher debt-to-equity
ratio leads to a higher required return on equity, because of the higher risk involved
for equity-holders in a company with debt. Moreover, Botosan and Plumlee (2004)
used Debt to Equity ratio variable (DE) to state that a positive relationship between
DE and cost of equity capital.
3.2.4. Book to market ratio (BM):
The book to market ratio (BM) is an important valuation measure in
order to find the value of a company by dividing the book value of a firm by its
market value. Botosan and Plumlee (2005) note that the cost of equity capital is

15


significantly related to book-to-market value. Penman (1991) argues that low BM
firms remain more profitable than high BM firms, or BM is expected to relate
positively to cost of equity.
However, Fama and French (1992) suggest that a firm’s stock returns and

book-to-market value have a negative relationship. In other words, a firm with a
higher book-to-market value is expected to have better stock returns. As a young
stock market, the herd mentality primary influences on the way individual investors
to make decisions. The market views that the weak current earnings of these high
BM firms (undervalued) as temporary and foresees profitability improving in the
future, low cost of equity is also expected by shareholders. In addition, a country’s
economic risk has related and influenced to book to market (Erb et al.,1996b). The
previous researchers found that economic risk rating of a country has negatively
related to book to market. That means when a country improves its economic risk
rating, BM would decrease. Moreover, Erb et al. (1996b) also gave an important
implication that there is a negative relationship between BM and cost of equity
capital in the case that the valuation of stock reflects these upward improvements in
economic fundamentals and capital flows to emerging markets related better
economic fundamentals.
3.2.5. Assets turnover ratio:
Assets turnover ratio, ATO, defined as total sales divided by average
total assets, is used as an indicator of managerial agency costs to test influence of
managerial agency costs on the cost of equity capital. Singh and Nejadmalayeri
(2004) documented that firm-level cost of equity capital is influenced by managerial
efficiency in utilization of firm resources. Ang et al. (2000) and Singh and Davidson
(2003) argue that the management’s ability to employ assets efficiently is assessed
via asset turnover ratio assess. Low asset turnover ratios mean that the company is
not managing its assets wisely as well as inefficient utilization of assets. They
indicate that the assets are obsolete. Low asset turnover ratios imply that the
companies have operated below their full capacity. Singh (2004) argues that firms
with higher assets turnover ratio—reflecting lower managerial agency problem in

16

Angetal’s (2000) framework—have lower cost of capital. A negative relationship
between ATO and cost of equity capital is expected.
Johnson and Mitton (2003) argue that ATO is of importance for Asian
firms in the light of recent evidence of corporate cronyism, which Rajan and
Zingales (2001) defined that the relationship between politicians and supporting the
financing of particular firms (sometimes known as “cronyism”) in these countries.
There are more benefits to firms with powerful political association, especial when
the imposition of capital controls allows a higher level of subsidies. Asset turnover
ratio is used as an indicator of managerial efficiency to test influence of managerial
efficiency on the cost of equity capital. As the results Johnson (2003) in Malaysia, a
positive relationship between ATO and cost of equity capital is expected.
3.2.6. Inventory to total assets:
One ratio used to assess operational management and inventory turnover is
inventory divided by total assets. In general, a low inventory to total assets ratio is
indicative of good performance and profitability. In Vietnam, the number of
manufacture firms is the highest in total listed stocks and because inventory
influences directly on these firms’ performance, hence this is a factor worth taking
into considering.
Feng et al. (2013) defined internal control as a process affected by an
organization's structure, work and authority flows, people and management
information systems, designed to help the organization accomplish specific goals or
objectives. He states that a high level of inventory also raises the internal control risks
related to the proper measurement and recording of inventory and this is reflected in
the rising cost of equity. In addition, the quality and liquidity of current assets are
largely dependent on the composition of current assets. The lower the percentage of
inventory to the current assets, the greater the liquidity of current assets and viceversa, or it means that a low this ratio is better than high ratio (BOSE, 2006). A
positive relationship between the level of inventory to total assets and cost of equity
would be expected.

17

CHAPTER IV

DATA & METHODOLOGY

This chapter describes the highlights of data, the way used for gathering figures of
different sources; research methodology employed; and research framework. In this
dissertation provides the test process including econometric assumptions as well.
4.1.

Data:
In Vietnam, there are two main stocks exchanges namely Ho Chi Minh

Stock Exchange (HOSE) starting trading on 27/08/2000 and Hanoi Stock Exchange
(HNX) starting trading on 14/07/2005. Vietnam stock market can be divided into
three main periods until now, the initial period is from 2000 to 2005, this is the
start-up period and market movement is unstable. The second period is from 2005
to 2008, a nonstandard return that only happens once in 60 years (Hua Chia Yee,
CFA) did occur with Vietnam stock market in this period. In addition, the beta is
commonly estimated using data over two years, so we choose the rest period from
2009 to 2012 in order to minimize Beta error (Hua Chia Yee, CFA). Hence, the
study would obtain the listing companies which had been non-stop trading and
listed for at least two years because we use covariance with VN-index as the
fundamental of calculating beta.
According to that, the number of chosen stocks would be number of
companies listed before 2007 and they are not de-listed during the period 20092012. For each stock, the firm-specific variables (Total Asset, Asset turnover ratio,
Debt to Equity ratio, Book to market, Inventory) would be collected in the end of
the year for eliminating the effects of seasonal fluctuations.

18


In general, panel data models are more “efficient” than pooling crosssections (Michael Hauser, Financial Econometrics, 1292). Panel data analysis is a
method of studying an exacting subject within multiple sites, periodically observed
over a defined time frame. With the combination of time series with cross-section
contributes on investigating the dynamics of change with short time (Gujarati, 2003;
638-640).
The raw data including stock price for calculating Beta, Total asset, Debt
to Equity ratio, Book-to-Market ratio, Asset turnover ratio, Inventory to Total
Assets would be accumulated from Bloomberg’s source, other financial websites
such as vietstock.vn, vndirect.com.vn. It is necessary to check whether data
collected is the most reliable or not. After gathering the numbers, ratios of 10 firms
are chosen randomly from three different sources mentioned above and compared
with firms’ actually financial statements. The result shows that Bloomberg is the
most verifiable source.
As mentioned in the Literature Review section, firm-specific factors
would be calculated with some ways below
BETA

= stock return covariance with VN-Index return in 2009-2012

SIZE

= Log of a firm’s total asset

DE

= Total debt-to-total market value of equity ratio at the end of year

BM

= The book value per share divided by market price

ATO

= Total sales divided by average total assets.

INV

= Inventory divided by total assets

All amassed figures are put into panel data table.

19