Corporate income taxes and firms financing decisions the case of vietnamese tax incentives

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY

ERASMUS UNIVERSITY ROTTERDAM
INSTITUTE OF SOCIAL STUDIES
VIETNAM
THE NETHERLANDS

VIETNAM – THE NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

CORPORATE INCOME TAXES AND FIRMS’
FINANCING DECISIONS: THE CASE OF
VIETNAMESE TAX INCENTIVES

BY

PHAM NGUYEN QUANG HOA

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, DECEMBER 2017

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UNIVERSITY OF ECONOMICS
HO CHI MINH CITY

ERASMUS UNIVERSITY ROTTERDAM
INSTITUTE OF SOCIAL STUDIES

VIETNAM
THE NETHERLANDS

VIETNAM – THE NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

CORPORATE INCOME TAXES AND FIRMS’
FINANCING DECISIONS: THE CASE OF
VIETNAMESE TAX INCENTIVES

A thesis is submitted in partial fulfilment of the requirement for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

BY

PHAM NGUYEN QUANG HOA

ACADEMIC SUPERVISOR

Prof. Dr NGUYEN TRONG HOAI

HO CHI MINH CITY, December 2017

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CERTIFICATION
This is to certify that this thesis entitled “Taxes and Corporate Financial
Decisions: The Case of Vietnamese Tax Incentives”, which is submitted by me in
fulfillment of the requirements for the degree of Master of Art in Development

Economics to Viet Nam – The Netherlands Programme (VNP). To the best of my
knowledge, my thesis does not infringe on anyone’s copyright nor violate any
proprietary rights and that any ideas, techniques, quotation, or any other material
from the work of other researchers in my thesis, published or otherwise, are fully
acknowledge in accordance with the standard referencing practices.

PHAM NGUYEN QUANG HOA

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ACKNOWLEDGEMENT
I would like to thank my supervisor, Dr. Nguyen Trong Hoai for his
comprehensive guidance, great support and valuable advice he has given through
my research study. I have been very lucky to a supervisor who took a high cared
about my work and who respond to my question. He consistently allowed this
paper to be my work but steered me in the right the direction whenever he
thought I needed it. His careful editing contributed enormously to the production
of this thesis.
I also would like to thank my co-supervisor Dr. Truong Dang Thuy for his
enthusiastic support, availability and constructive suggestion, which help me
overcome the challenge and high-pressured situation during the time of research.
I would like to express my gratitude to all lecturers of the Vietnam- Netherlands
Program who have provided an interesting lesson to build my economic
knowledge during this program. Besides, completing this work would have been
difficult if it is not supported by my best friends. I am indebted to them for their
help. Moreover, I wish to thank all my friends who are in VNP 21 who share
unforgettable memories in this program.
Finally, there are also words of deep gratitude for my family who support and
encourage me when I implement my postgraduate studies.

Pham Nguyen Quang Hoa
December, 2017

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ABSTRACT
Based on the tax incentives policy enacted by Vietnamese Government in the
year 2004, this paper applies Difference in Difference method and compares the
debt- equity ratio of treatment and un-treatment (control) companies before and
after this policy to determine the impact of corporate taxes’ change on firm’s
capital structure. The treatment group is state enterprises and otherwise is control
group. The data is collected in the period from 2001 to 2007, therein data related
to the period 2001- 2003 is pre-treatment data and those in the period 2004-2007
is post- treatment date. Similar to prior capital’s literature, the empirical results
expose that that taxation actually has impact on leverage. The measured impact is
approximately -4.1 percentage point, meaning that with the introduction of
incentive tax policy, the debt ratio of companies reduces more than 4 percentage
point. The evidences also indicate that the large companies absorb the effect of
tax change more than Small and Medium Enterprises and also are high significant
level.

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LIST OF TABLES
Table 1: Variables’ definitions and measurement................................................23
Table 2: Descriptive Statistics and Means Differences for the period 2001-2007
..............................................................................................................................28

Table 3: Descriptive Statistics and Means Differences for the year 2003 ...........29
Table 4: Impact of Taxation on Company’s Capital Structure ............................34
Table 5: Small and Medium Enterprises versus Large Companies .....................36

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LIST OF FIGURES
Figure 1: The mechanism of the relationship between taxes change and financial
structure ................................................................................................................18
Figure 12: The difference between two groups after exogenous event ...............22
Figure 3: Common trend over time
Figure 3- Panel A: Leverage ................................................................................30
Figure 3- Panel B: Assets .....................................................................................30
Figure 3- Panel C: Labor ......................................................................................46
Figure 3- Panel D: Liquidity Ratio ......................................................................46
Figure 3- Panel E: Investment ..............................................................................47
Figure 3- Panel F: Tangibility ..............................................................................47
Figure 3- Panel G: Profitability............................................................................48
Figure 3- Panel H: ROE .......................................................................................48
Figure 3- Panel I: Profit Margin ...........................................................................49
Figure 3- Panel K: Inventories Turnover .............................................................49
Figure 4- Bivariate Analysis
Figure 4- Panel A: Leverage- Assets ...................................................................50
Figure 4- Panel B: Leverage- Labor ....................................................................51
Figure 4- Panel C: Leverage- Liquidity Ratio ....................................................52
Figure 4- Panel D: Leverage- Investment ............................................................53
Figure 4- Panel E: Leverage- Tangibility ............................................................54
Figure 4- Panel F: Leverage- Profitability ...........................................................55
Figure 4- Panel G: Leverage- ROE ......................................................................56

Figure 4- Panel H: Leverage- Profit Margin ........................................................57
Figure 4- Panel I: Leverage- Inventories Turnover .............................................58

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LIST OF APPENDICES
ANNPENDIX A1: FIXED EFFECT TEST.........................................................59
ANNPENDIX A2: RANDOM EFFECT TEST...................................................60
ANNPENDIX A3: HAUSMAN TEST ................................................................61

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CONTENS
CHAPTER 1. INTRODUCTION ................................................................................................ 10
1.1.

Problem statement ........................................................................................................ 10

1.2.

Research objectives ...................................................................................................... 12

1.3.

Organization of the study ............................................................................................. 12

CHAPTER 2. LITERATURE REVIEW ..................................................................................... 14
2.1.

Tax changes.................................................................................................................. 14

2.1.1.

Tax changes are observed over a long period ...................................................... 14

2.1.2.

Tax change is considered as an exogenous event. ............................................... 15

2.2.
Measurements of capital structure and several elements have impact on capital
structure.................................................................................................................................... 17
2.2.1.

Measurements of cCapital structure ..................................................................... 17

2.2.2.

The impact of several elements on capital structure. ........................................... 18

2.3. Two main methodologies and empirical results regarding the effect of tax changes on
capital structure’s decision in prior researches ........................................................................ 21
2.3.1.

Two main methodologies in prior researches ...................................................... 21

2.3.2.

Empirical results in prior researches’ summary ................................................... 22

2.4.

Chapter remark ............................................................................................................. 24

CHAPTER 3: DATA AND METHODOLOGY .......................................................................... 27
3.1.

Data source ................................................................................................................... 27

3.2.

Empirical model ........................................................................................................... 28

CHAPTER 4: RESULTS AND DISCUSSION ........................................................................... 34
4.1.

Descriptive statistics .................................................................................................... 34

4.2.

Bivariate analysis ......................................................................................................... 36

4.3.

Regression results ........................................................................................................ 42

4.3.1

Impact of Corporate Tax Incentives on firms’ capital structure .......................... 42

4.3.2

Impact on Small and Medium Enterprises versus Large Companies ................... 45

4.3.3

Discussion of research results .............................................................................. 47

CHAPTER 5: CONCLUSION AND POLICY IMPLICATIONS .............................................. 50
5.1.

Conclusion ................................................................................................................... 50

5.2.

Policy implications ....................................................................................................... 51

5.3.

Limitation of the study ................................................................................................. 52

REFERENCES ............................................................................................................................ 54
ANNPENDIX .............................................................................................................................. 72

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CHAPTER 1. INTRODUCTION
1.1. Problem statement
If a business has used debt in its capital structure and the amount of the debt
within the permitted level that the lenders cannot demand a higher interest rate, it
will take advantage from the debt tax shield. Since the cost of lending (proxied
by interest) is deducted before calculating taxable profits, reduce profits, thereby,
reduces the corporation tax of income that businesses must pay. Some studies
found the empirical evidences to support that taxes do effect on capital structure.
However, it exists not less debates around this theory. From the very first days of
capital theories, Modigliani and Miller (1958), Miller (1977) and DeAngelo and
Masulis (1980) desired to measure the impact of debt tax shield on corporate
financial decisions. They found the evidences suggesting that the more
companies use debt to finance business, the more their own capital structures
change related to tax benefit. To the recent papers (Panier, Perez-Gonzales, and
Villanueva, 2012; Princen, 2012; Faccio, Xu, 2015; …), these authors supply
empirical results that tax benefit from debt tax shield effects firms’ leverage.
Princen (2012) used Difference in Difference model for the period 2001- 2007 to
present that an equal tax treatment between debt and equity encouraging
companies to use 2-7 percent less debt than a traditional tax system. Panier,
Perez-Gonzales and Villanueva (2012) approached in another aspect that is the
equity ratio (the ratio between equity value and total assets) and showed the
equity ratio of Belgium firms substantially rising from 32.6 percent in 2004 and
2005 to 34.2 percent in two following years. In this case, 2004 is the year the tax
reform had been valid.
Vietnamese corporate tax rules can be considered as a traditional tax system
(Graham, 2003). Companies are taxed on their profits (the business income less
the costs to generate that income). Those business that related costs included in
the interest paid as return to the creditors. Since these interest expenses reduces
taxation income (tax deductibility). However, the returns to shareholders or

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dividends are included in the taxable base and are taxed. On November 16th
2004, Vietnamese government enacted the Decree No.187/2004/NĐ-CP
regarding to “Transferring state enterprises to joint stock companies”. There was
a preferential tax policy (corporate tax) applied for state enterprises performing
equitization. Particularly, according to Term 1, Article 36 of this Decree, afterequitization enterprises are entitled to the incentives exactly like new business
establishment according to the current Vietnamese law which is the Decree
No.164/2003/NĐ-CP valid on December 22nd 2003 regarding “Detailed
regulations on the implementation of corporate income tax law”. Whereby, the
income corporate tax ratio for business establishments was 28 percent (Term 1,
Article 9) and preferential tax ratio applied for new business establishments was
10-20 percent depending on geographical areas and industry fields (Term 33).
Hence, the income corporate tax ratio for state enterprises performing
equitization was reduce 08-18 percent after the introduction of Decree
No.187/2004/NĐ-CP. Several forms of equitization that companies might
conduct including: firstly, maintaining the current state capital and issuing more
firms’ shares; secondly, selling a part of state capital and associated with issuing
more firms’ shares; thirdly, selling all state capital and associated with issuing
more firms’ shares. On February 14th 2007, the Decree No. 24/2007/NĐ-CP
(from the Term 2, Article 46) regarding “Detailed regulations on the
implementation of corporate income tax law” had rejected the tax incentives for
state enterprises transferring joint stock companies as ruled in the Term 1, Article
36 of Decree No. 187/2004/NĐ-CP. Therefore, the joint stock companies that had
been established from equitization state enterprises before the expired date of the
Decree No. 24/2007/NĐ-CP expired, continued to take advantage from tax
incentives for the remained time. By the other word, the state enterprises
transferring joint stock companies established after February 14th 2007 could not
have benefit from tax intensives.

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This study develops a model to investigate the impact of this tax reform on
Vietnamese firms’ leverage. The empirical results from this model display that
further to preferential tax rates, companies reduce their own leverage. Difference
in Difference identification strategy is used to compare the leverages of two
groups, therein state enterprises are determined the treated group and the
remaining companies play the control group. The period of time from 2001 to
2007 is divided into two stages, the sample related to the period 2001 to 2003
belongs to the pre-treatment data and those in the period 2004- 2007 is the posttreatment data.
Deriving from the controversy surrounding the effect of tax changes on firms’
capital structures and an ideal historical event in Vietnam as mentioned above,
this study desires to answer these questions following: First, does it exist the
relationship between preferential tax policy and corporate financing decisions
and if it does exist, is it a positive or negative relationship? Second, does the
Large Companies or Small and Medium Enterprises (SMEs) adjust their own
leverage ratios more to the tax changes?
1.2. Research objectives
There are two crucial research objectives of this study.
Firstly, investigating the effects of preferential tax policytax changes on
companies’ capital structures.
Secondly, determining which type of companies respond their own financial
decisions to tax changes more, among Large Companies and SMEs.
1.3. Organization of the study
The remainder of this study is organized as follows. In chapter 2, I review several
previous researches including the main approaches to define the tax changes;
several measurements of capital structure and listing some different elements that
have impact on capital structure’s decision; briefly describing two popular

methodologies applied in regressions and accentuating the empirical results

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regarding the effect of tax changes on capital structure’s decision. Chapter 3 is
research methodology and data. This chapter discusses the identification strategy
and establishes empirical specification. Chapter 4 reports the main regression
results and Chapter 5 concludes the discussions.

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CHAPTER 2. LITERATURE REVIEW
This chapter includes four sections which will follow the introduction from this
chapter mentioned above. Firstly, I summarize two main approaches that
previous researchers applied to define the tax changes. Secondly, I desire to list
several different the measurements of leverage ratios or debt ratios (proxied for
the capital structure). Not only the tax changes but also abundant elements were
found in previous literatures that have impact on capital structure’s decision and
they are also listed in this part. Thirdly, I list two popular methodologies applied
in regressions including Ordinary Least Square (OLS) and Difference in
Difference (DID). I also accentuate the empirical results regarding the effect of
tax changes on capital structure’s decision that I observe in prior researches. The
final part of this section is chapter remark.
2.1.

Tax changes

Tax changes or tax reforms play the independent variable in the causality

between them and capital structure. To measure the impact of tax changes on
firms’ capital structures, there are properly two main approaches being applied in
various previous studies. Firstly, tax changes over a long period of time in a
particular country or area are observed to examine whether if there is any
correlation with firms’ capital structures. Secondly, tax changes or tax reforms
are considered an exogenous event and the companies’ financial decisions are
researched before and after a tax reform in a particular country.
2.1.1. Tax changes are observed over a long period
A considerable contribution about this approach can be mentioned is belonged to
Faccio and Xu (2015). They noticed that there are 84 changes in corporate tax
rates and 298 changes in personal tax rates among OECD countries from 1981 to
2009. There are three benefits from using of a multitude of shifts in statutory tax
rates, both at the corporate and at the personal level, particurlarly, confirming the
impact of tax changes on financial decision of firms throughout the time- series
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proofs , thus, reducing the risk of a spurious result; solving the problems arising
from personal taxes apart appraise the influence of diverse kinds of taxes on
firms’ leverage; and taking advantages from the number of tax changes within
long period of time causes increasing the quality of data and the reliance of
empirical results.
In the year 2015, in attempt to illustrate that taxes are an important determinant
of capital structure choice of firms, Heider and Alexander based on 121 changes
in state’s corporate income tax rates across US states, including tax increases and
tax cuts over the period 1989- 2011 to point out several empirical analyses have
been implemented to contribute these arguments. Exactly 16 years ago from the
foregoing authors, Roger and Lee (1999) who were the pioneers in that kind of
research inferred the degree to which firms of different sizes do change their
financial structures in response to tax incentives, based on the abundant changes

in tax structures and small corporations face much lower marginal tax rates than
larger firms in a long period of time from 1954 to 1995. Tax changes mostly take
their actual values in the empirical models of these studies.
2.1.2. Tax change is considered as an exogenous event.
There was a tax reform that was adopted in the year 2006 by Belgian
Government called Notional Interest Deduction (NID). Belgium firms and
foreign firms permanently established in Belgium are allowed to deduct a
notional return of their book value of equity. This reduction is the 10-year
Belgian government bond rate in average of the year (t- 2), It is limited with
maximum value at 0.5 percent and cannot vary more than 1 percentage point
annually. This tax regime leads to a reduction in tax discrimination between debt
and equity. This tax reform in Belgium in 2006 seems to be an ideal exogenous
event for abundant authors developing their researches. Not only Panier, PerezGonzales and Villanueva (2012) but also Katrien, Cauwenberge and Christiaens
(2012) applied this event. However, each research has different samples from
each other. For example, the samples of Panier et al. are Belgian companies while
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Katrien et al. focused on small and medium entrepreneurs. In addition, one
another author- Princen (2012) also accessed directly this event under a tittleAllowance for Corporate Equity (ACE) which is similar to Notional interest
deduction (NID)- an equity tax relief. This tax system attributes a similar tax
deductibility to the return on equity as the generally implemented deductibility
for interest expenses of debt. As such, tax neutrality between two main sources of
finance is ensured and corporate taxation no longer favors debt over equity.
In 2013, Lin and Flannery based on the 2003 tax cut named The Jobs and Growth
Tax Relief Reconciliation Act (JGTRRA) in US for checking how taxes can
influence on firms’ leverage. Regarding this tax reform, there are the declines in
dividend tax rates (from 38.6 percent in maximum to 15 percent) and capital
gains tax rates in long- term (from 20 percent in maximum to 15 percent) applied
to the personal investors. This event can be considered as an exogenous event and

generates a perfect condition to examine the effect of individual taxation on
capital structure’s choices.
Returning back to a further past, in 1997- 1998, a tax reform had been
implemented in Italy (Staderini, 2001), termed Dual Income Tax (DIT) and taxed
interest payment through the New Regional Tax on Value Added (IRAP).
Particularly, DIT system taxation which was introduced in 1997 reduced the tax
rate of 19 percent to the taxable income representing the opportunity cost of
equity (shareholder’s fund). The normal rate of 37 percent is applied to income
exceeding cost. In 1998, the new tax on business activity was introduced (named
IRAP) replacing the prior tax system (ILOR). It based on the value added and
had a rate of 4.25 percent, the taxation of profit was reduced from 53.2 percent to
41.25 percent (37+4.25). The new regime reduced being in favor of debt in firms’
behavior.
More than two decades ago, there was an extremely legendary tax reform in US
1986 that inspired to the scientific communication to implement the workouts
regarding to the relationship between taxes and financial structures’ companies.

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This is The Tax Reform Act 1986 (TRA) in US that changed the tax regime
which lowered the corporate tax rate (reducing the value of tax shields to firms)
and cut personal tax rates (Givoly, Hayn, Ofer, and Sarig, 1992). According to
Gordon and Jeffrey (1991), this action seemed to be the most extensive change in
the US tax law since the World War II. To the beginning, the maximum tax rate
was cut from 46 percentage in 1986 to 40 percentage in 1987 and 34 percentage
in 1988 and thereafter. This rate was now applied to income over $75.000,
instead of $100.000. Tax changes in the empirical models of these studies are
commonly proxied by a dummy variable which takes value one for the period
after tax change and zero for otherwise.

2.2.

Measurements of capital structure and several elements have impact

on capital structure
2.2.1. easurements of cCapital structure
Capital structure is proxied by firm’s leverage ratios or debt ratios. Leverage
ratios are the influent factors in the causality between taxes changes and capital
structures. There are abundant measurements of leverage ratios according to
every scientist’ss points of views.
In the initial period when the question whether taxes affect corporate financing
decisions had been raised, firm’s debt ratio is calculated as sum of annual book
value of long term debt divided by sum of long-term debt and the market value of
equity (Bradley, Jarrell and Kim, 1984). This formula had been applied in a
variety of afterward analysis, typically, Givoly, Hayn, Ofer, and Sarig (1992)
with a research regarding to The Tax Reform Act 1986 (TRA).
Several arguments appeared from which value is suitable for calculation and
whether lead to exact results, book value or market value. It seems to be a
difficult issue caused the different angles in scientific communication and the
samples’ characteristics that they collected. However, book value with some
advantages including the ability to effortlessly exploit from financial statements

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is usually favored. Roger and Lee (1999); Staderini (2001); Katrien,
Cauwenberge and Christiaens (2011); Princen (2012) and Lin and Flannery
(2013) also measured leverage equals the average book debt over average book
assets. The combination between book value and market value had been defined
to improve the robustness as can be seen in the analysis of Frank and Goyal

(2009) with a variety of ratios like total debt over market value of assets, total
debt over book value of assets, long-term debt over market value of assets and
long-term debt over book value of assets; or the contribution of Heider and
Ljungqvist (2015) consisting of long- term book leverage, total book leverage
and long-term market leverage with similar formulas. A remarkable feature that
could be noticed is a different calculation for leverages as the value of equity
divided total assets instead of contrary as usual. It can be seen in studies of
Panier, Perez-Gonzales and Villanueva (2012) and Schepens (2016).
2.2.2. The impact of several elements on capital structure.
Besides the purpose related to determine the main relationship between tax
changes es and firms’ leverage, several independent variables have been added in
the regressions according to capital structure literatures.
Firm size  please give a subtitle for each element that you would like to

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consider

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Firm size

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The most popular factors that are

easily observed are is firm size (usually

measured by logarithm of total assets). Firm size in this regression has a positive
relationship with leverage, which would reflect the stable cash flows of bigger

firms and they seem to use more debt to maximize the benefit from tax shields
(Marsh, 1982). Studies of Schepens (2016), Lin and Flannery (2013), Princen
(2011) also show the similar effect. Gorden and Lee in a research in 1999
inferred the degree to which firms of different sizes do change their financial
structures in response to tax incentives. The empirical results denote that taxes

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have strong effect on debt levels. In particular, taxes have large effect on leverage
of smallest and largest firms and much less effect on intermediate firms.
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Firm size?Labor
Labor (number of employees) is also a factor seem to have negative impact on

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capital structure. Serfling (2013) found that firms lower their debt financing when
they confront higher labor costs. One of the reasons might be higher employee
costs also lead to higher financial distress cost. Therefore, firms tend to induce
their leverage ratios.
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Liquidity ratio
Liquidity ratio that usually calculated by total assets value excluding inventories
dividing total debt has negative effect on leverage. That means the more liquid
assets firms have, the less they use debt to finance their operation. Titman, S. and
Wessels (1988) supposed firm with low liquidity might have high bankruptcy

cost when they fall into the financial distress that can happen with too high
leverage ratio. Hence, liquidity is expected to have a negative impact on debt
ratio.

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Investment
Another pretty significant factor can be counted here is the investment value that
calculated by the differential fixed assets value between this year and the
previous year. It can be a negative relationship between investment value and
firms’ leverage because with the high value of investment, firms’ managers tend
to deduct protective activities regarding the leverage ratio. They fear of facing
financial distress associated with invested opportunities. Hence, lowering debt in
capital structure might be their choices. It has been applied in Princen (2012);
Klemm and Parys (2011); Frank and Goyal (2009); Chirinko and Wilson (2008)

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Tangibility
Tangibility equals to tangible assets (net property, plant, and equipment) divided
by total assets that usually has the negative impacts on leverage. One of a reason

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to explain is the deductible expenses after tax from depreciation may have
stronger influence than debt financing (Princen, 2012).
Profitability
Profitability (Ratio of earnings before interests, taxes, depreciation and
amortization (EBITDA) to book value of total assets) appears in a mass of studies

of Schepens (2016), Lin and Flannery (2013), Princen (2011), Katrien,
Cauwenberge and Christiaens (2011), Frank and Goyal (2009), etc. According to
Rajan and Zingales (1995), causes companies tend to have a favor of using
retaining earning for profitability target, leverage may have the negative
correlation with profitability.
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ROE
ROE (Return on Equity) is calculated by net income (earning before tax) returned
as a percentage of shareholders’ equity usually has the positive effect on
leverage, it refers that the more the return on equity firms possess, the more they
tend to increase their leverage. The similar effect can be seen in studies of Lin,
and Flannery (2013), Princen (2011), etc.

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Profit margin
Profit margin is the ratio of net income (earning before tax) to total sales. It
frequently has negative impact on firms’ leverage ratio which might be explained
by profitable firms tend to finance their operating activities by retained earning
rather than debt (Yogendraraja and Thanabalasingam, 2011). This regression can
be defined in studies of Princen (2012), Schepens (2016), etc.

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Inventories turnover
Inventories turnover (measured by inventories value divided total sales) and
capital structure tend to interact with each other, since material and cash flow
managements are two basic factors of businesses. According to Hu, Li and Sobel
(2011), capital creates material and cash reverse comes from turnover (sales of

commodities). Hence, this circulation generates the interaction between
operational decisions (including inventories management) and financial decision.

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Inventories turnover is decided to add in this study’s regression to control the
impact of operational activities on firms’ leverage.
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Net operating loss
Net operating loss (NOL) indicates the “negative profit” for tax purposes as can
be called tax losses carryforward which can reduces companies’ tax expense for
the next financial year. This element appears in the research of Princen (2012)
and has the negative impact on firms’ leverage. In this study’s regression, NOL is
a dummy variable, takes the value one if the company is loss- making and zero in
other case.

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Macro- economic indicators
In addition, some macro- economic indicators have been frequently added in the
regressions to control macro- economic conditions including inflation proxied by
the annual percentage of inflation in consumer prices as measured by the World
Bank and GDP Growth is the annual percentage of GDP per capita growth as
measured by this same institution (Princen, 2012). In a contribution of Gajurel
(2006), this author indicated that there is a negative relationship between GDP
growth and short- term debt ratio but a positive relation with long- term debt
ratio. Furthermore, Gajurel also show the consistent empirical results regarding
the relationship between inflation and short- term, long- term debt ratio.

2.3.

Two main methodologies and empirical results regarding the effect of

tax changes on capital structure’s decision in prior researches
2.3.1. Two main methodologies in prior researches
A common methodology to examine the impact of tax changes on capital
structure is Ordinary Least Square (OLS). Suppose that there is causality between
the cause and the effect (a change in X leads to a change in Y), they are taxes
changes and firms’ leverage in this case. It can be seen in the researches related
to taxes change over a long period of time (Faccio and Xu, 2015; Phan, 2011).

21

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Another methodology that can be seen in variety of analyses regarding
researching the companies’ financial decisions before and after tax reform in a
particular country is Difference in Difference (DID). In this case, tax reform (or
tax change) plays the exogenous event that may be represented by a dummy
variable, takes value one for the period of time after tax reform and zero value for
the period of time before tax reform. Commonly, tax reform only affects a certain
group of enterprises that can be seen as treatment group. Companies that are not
affected play as un-treatment or control group, so there is an underlying
difference between these groups. The impact of tax policy may be evaluated from
the different leverage ratios of two groups before and after tax reform. This
methodology is applied in series of prior researches such as Panier, PerezGonzales and Villanueva (2013); Princen (2012) and Kestens, Cauwenberge and
Christiaens (2012)
2.3.2. Empirical results in prior researches’ summary

Most of previous researches seem to have several similar results that tax
changeses do have effects on firms’ financial leverage. However, the specific
impacts are not consistent, some studies represent the positive relationship
besides that others show the negative correlation between tax changes and firms’
leverage.
Studies represent positive relationships:
A study of Heider and Ljungqvist in 2015 also proved taxes are an important
determinant of capital structure choice of firms. Over the period 1989- 2011,
there are 121 changes in state’s corporate income tax rates across US states,
including tax increases and tax cuts, the authors applied DID approach to
examine the effect of changes in state’s corporate income tax rates on firms’
leverage. Data in this research consists of all US companies from 1989- 2011.
The group of firms experiencing a tax change in their home state is treated firms
and others not subject to a tax change in their home state are control group, for

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comparison. Specifically, they found that firms increase long-term leverage in
response to the increase in tax rates, and beside that, they remain their leverages
when tax rates fall.
In a contribution in 2013, Lin and Flannery compared companies’ leverages in
2002 and 2004 after a US tax decline in 2003 to examine the impact of personal
taxes on firms’ debt ratio. With the application of DID method, they found that a
company that the last owner was a person decreased its book leverage value
approximately 5 percentage points compared to the average value of the whole
sample (19.9 percent) in 2002 in respond to the tax change. This empirical result
stated obviously that the individual taxation reduces firm leverage.
There is a series of analysis paying attention on tax reform event in 2006 in
Belgium and they virtually have similar results that Belgium companies’ leverage

significantly responds to changing tax incentives, particularly, corporations are
no longer favors using debt over equity in their capital structures so they decrease
their financial leverage (Panier, Perez-Gonzales and Villanueva, 2013; Princen,
2012 and Kestens, Cauwenberge and Christiaens, 2012).
Likewise, Staderini (2001) verified the role of tax changes on corporation
financial structure, in this case the tax changes are tax reform in 1997-98
(reducing the tax rates). Data is collected in the period of time 1992- 1998 and
divided into 2 groups: Firms posse the requirements required by law to use the
DIT tax system (group 1) and another one. The empirical results show that firms
reduced their leverages as the response to tax changes
Driving from the Tax Reform Act of 1986 in US, Givoly, Hayn, Ofer, and Sarig
(1992) and Gordon and Mackie-Mason (1991) found that the association between
leverage and corporate tax rates is positive and provide various incentives to
increase debt finance. Furthermore, there is a substitution effect debt and nondebt tax shields and personal tax rates affect firm’s leverage.
Studies represent negative relationships

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Schepens (2016) investigated the impact of tax on the capital structure decisions
of financial institutions by applied DID approach. Based on a tax reform was
introduced in Belgium in 2006, this author collects the data of Belgium banks
(treatment group) and European banks (control group) between 2003- 2007. The
period 2006- 2007 is post treatment. His first crucial finding is that tax shields
have a significant impact on bank capital structure decisions, particularly,
increasing the equity ratio. The second result is the impact of the change in tax
treatment is driven by an increase in bank equity and not by a reduction of
activities.
Studies represent both positive and negative relationships
Faccio and Xu in a research the year 2015 based on the changes in corporate tax

rates and personal tax rates among OECD countries from 1981 to 2009 (184 and
298 changes, respectively) to test the effect of tax changes on firms’ financial
decision. This study indicated that capital structure choices are affected by both
corporate and individual taxes: there is a positive relationship between corporate
taxes and there is a negative relationship between personal dividend taxes and
firms’ leverage in contrary.
Phan (2011) investigated the impact of income tax regime on capital structures of
Vietnamese listed firms in the period from the year 2005 to June 2010. By
applied the OLS method and the samples including 219 listed firms in Ho Chi
Minh Stock Exchange (HOSE), the empirical results indicated that personal
income taxes have significantly negative influence on Vietnamese debt ratios and
there is a positive relationship between corporate income taxes and both long and
short- term debt ratios in the year 2008.
2.4.

Chapter remark

In this study’s background, Vietnamese tax reform in the year 2004 is a suitable
to research the difference between firms’ financial decisions before and after this
event by using DID methodology. This tax reform is a preferential tax policy or
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tax incentives. Particularly, the income corporation tax rates for businesses had
been 28 percent before tax reform, and after that they decreased to 10 – 18
percent applied for state enterprises performing equitization. The state enterprises
might play the role as the treatment group and the remaining companies which
are not affected by this tax policy is the control group. The year 2004 is the time
this tax reform was valid, so the period of time before 2004 is the time pretreatment and after 2004 is the time post-treatment. Figure 1 below briefly

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describes the mechanism of the relationship between tax changes and financial
structure. Please draw a map for your conceptual framework which tell us your
key relationship together with your controlled elements already discuss in this
chapter

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