Debt tax shield and firm value empirical evidence from listed companies in vietnam

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

ERASMUS UNVERSITY ROTTERDAM
INSTITUTE OF SOCIAL STUDIES
THE NETHERLANDS

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

DEBT TAX SHIELD AND FIRM VALUE:
EMPIRICAL EVIDENCE FROM LISTED
COMPANIES IN VIETNAM

BY

NGUYEN THI HONG HOA

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, OCTOBER 2017


UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

VIETNAM - NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

DEBT TAX SHIELD AND FIRM VALUE:
EMPIRICAL EVIDENCE FROM LISTED
COMPANIES IN VIETNAM

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

By

NGUYEN THI HONG HOA

Academic Supervisor:
VU VIET QUANG

HO CHI MINH CITY, OCTOBER 2017


ACKNOWLEDGEMENT

I would first like to thank my thesis supervisor Dr. Vu Viet Quang of the Vietnam –
The Netherlands Programme (VNP) at Ho Chi Minh City University of Economics.
He consistently allowed this paper to be my own work, but steered me in the right the
direction whenever he thought I needed it.
I would like to express my gratitude to the VNP officers who were involved in my
thesis process by updating thesis schedule and providing good condition for my
research process. Without their passionate participation, the thesis process could not

have been successfully conducted.
Finally, thanks are also due to my classmates for providing me with unfailing
support and continuous encouragement throughout my years of study and through the
process of researching and writing this thesis. This accomplishment would not have
been possible without them. Thank you.

Nguyen Thi Hong Hoa
Ho Chi Minh City, October 2017

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ABSTRACT

In the present study, panel data in fiscal year from 2008 to 2015 has been collected to
reveal the interaction between debt tax shield and firm value. The main purpose is to
examine the value of debt tax shield and its effect on firm value toward taxation. The
reverse approach is employed in which the future profitability is regressed on firm
value and debt using non-linear least square. The advantage of reverse method is to
shift measurement bias in future operating income to the regression residual and to
enhance the usefulness of market factors to control for risk and expected growth. This
way also includes nontax information in the market value variable. As a result, debt
tax shield has negative effect on firm value. The predicted value for debt tax shield
approximately gets 37 percent of debt or gets 9.5 percent of firm value.

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TABLE OF CONTENT

Chapter

Page

Acknowledgement ...............................................................................................i
Abstract .............................................................................................................. ii
Table of content ................................................................................................ iii
List of tables .......................................................................................................v
List of figures ....................................................................................................vi
1. Introduction ........................................................................................................1
1.1. Research problem ........................................................................................ 1
1.2. Research objective ....................................................................................... 2
1.3. Scope of study ............................................................................................. 2
1.4. Thesis structure ............................................................................................ 3
2. Literature review ................................................................................................ 4
2.1. Theoretical review ....................................................................................... 4
2.1.1. Modigliani and Miller and capital structure theory (MM Model) ......4
2.1.2. Trade-off theory .................................................................................. 5
2.1.3. Theory of Agency costs ......................................................................9
2.2. Empirical review ....................................................................................... 11
2.3. Hypothesis development ............................................................................18
3. Research methodology ..................................................................................... 21
3.1. Conceptual framework ..............................................................................21
3.2. Estimation method ..................................................................................... 22
3.3. Variables and measures .............................................................................29
3.4. Data Collection ........................................................................................... 36
4. Empirical result and discussions ......................................................................37
4.1. The statistic descriptions of variables ........................................................ 37
4.2. Empirical result ......................................................................................... 41
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4.2.1. Linear estimation ...............................................................................41
4.2.2. Nonlinear estimation ..........................................................................46
5. Conclusion ........................................................................................................55
Reference ......................................................................................................... vii
Appendix ...........................................................................................................xi

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LIST OF TABLES

Table 3.1. Variable description ..............................................................................36
Table 4.1. Descriptive statistics ............................................................................37
Table 4.2. Correlation ............................................................................................ 39
Table 4.3. Correlation (divided by total assets) ..................................................... 40
Table 4.4. Summary statistics from linear regression explaining the Value of firm
(un-deflated intercept) ............................................................................42
Table 4.5. Summary statistics from linear regression explaining the Value of firm
with deflated intercept ............................................................................43
Table 4.6. Valuation of debt tax shield (  ) from reverse regression, No Control for
Capitalization Rates ..............................................................................44
Table 4.7. Valuation of debt tax shield (  ) from quantile regression according to
industry effect ....................................................................................... 45
Table 4.8. Valuation of the debt tax shield (  ) from nonlinear Regression ......49
Table 4.9. Summary statistics from Nonlinear regression with interest expense ...50
Table 4.10. State ownership and firm performance from nonlinear Regression ....51

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LIST OF FIGURES

Figure 2.1. The optimal capital structure and the value of the firm ......................... 8
Figure 3.1. Conceptual framework .........................................................................22
Figure 4.1. Distribution of future operating income ..............................................38

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CHAPTER 1: INTRODUCTION

1.1. Problem statement
In corporate finance’s perspective, one of the most important decisions of a particular
firm is to determine the optimal level of its capital structure or financial leverage.
However, the issue of firm’s capital structure has been controversially argued among
researchers (Akhtar & Oliver, 2009). In addition, financial leverage has become more
important since there are a large number of corporations using debt as a main instrument
to raise its capital.
The relationship between taxation and capital structure has been empirically examined
from a large number of developed countries such as the U.S and European countries with
many institutional similarities. It is necessary for a research about enterprise taxation
influences to operating income in Asian countries. Vietnam context would be selected for
analysis because Vietnam is an Asian developing country with a low income and fresh
stock exchange compared to other economies in Asia.
At the aim of maximizing benefit and minimizing risk, a firm will choose the suitable
capital structure to balance the costs and the benefits. Therefore, the notion of deciding
the ratio between debt and equity is always concerned at high level. It is believed that the
tax policy affect the firm’s financing. Indeed tax is an essential component in firm’s

activities and affects firm’s debt policy basing on deduction from interest expense. It
seems like that the only channel for firms to obtain funds is through bank borrowing in
Vietnam. Discovering how big magnitude tax affects firm profitability to find out the
relationship between firm value, debt and corporate tax. By this investigation, it is
hopeful that there is appropriate guidance for effective application of debt. Thus, above
research context creates two research questions:
(1) Does debt give impacts on performance of Vietnamese firms?
(2) How big does the magnitude of net debt tax shield affect firm value?
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1.2. Research objective
This first purpose aims to value the magnitude of debt tax shield, besides that there is
another tendency to test the effect of tax to debt ratio in the scope of this research of
Vietnamese enterprise in the stock market. Many researches build firm value as function
of debt and unrecognized measures of future operating income, yet this study is based on
an approach by regressing future operating income on firm value, debt and controlling for
firm-level capitalization rates (Kemsley & Nissim, 2002). According to Kemsley and
Nissim (2002) relying on reversed approach of future operating income, any unexpected
result of profitability is collected to the regression residual without effecting on debt;
simultaneously, the market value as independent variable hold nontax information from
debt. In addition, considering the market value as market-based variable is useful to
control for the risk and expected growth by Kemsley and Nissim (2002). We use interest
expense to investigate the magnitude of debt. In case enterprises receive benefit from
corporate tax of debt, it is expected that there will have useful measures from revealing
this relationship. It is essential to find out the limitation sourcing from debt to restrict this
limitation of debt. Therefore, the main objectives of this study are:
(1) Examining the impact of debt on firm performance
(2) Value the magnitude of net debt tax shield. Giving some implications for
Vietnamese firms to improve their performance.

(3) Revealing the role of state ownership on firm performance
1.3. Scope of study
This study examines the effects of taxation on firm performance in the context of
Vietnamese companies. The firm data is collected from 262 companies in Ho Chi Minh
Stock Exchange in fiscal year 2008 to 2015 on the following required variables: total
assets, net operating assets, interest expense, debt, future operating income, total market
value. The firm performance in this research only focuses on financial performance. The

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panel dataset is collected from Orbit database and Ho Chi Minh Stock Exchange database
and data from Vietstock.
This study attempts to follow quantitative analysis by applying nonlinear least square
regression model on the panel data of Vietnamese firms, which are listed in Ho Chi Minh
Stock Exchange (HOSE). The panel data would be employed to review the operation of
firm performance when putting tax across years. At the aspect of econometric model, this
study utilizes the nonlinear least square regression model to examine the value of debt tax
shield relative to firm value.
1.4. Thesis structure
The remaining of this study includes four chapters. First, chapter 2 discusses the
theoretical and empirical literature related to taxation and its relationship with firm
performance. This section primarily introduces the definitions of key concepts in this
study, main theories about taxation and debt and lists out main empirical findings of
prominent studies on taxation relationship. This background would be the basis to form
the conceptual framework utilized in this study. Second, chapter 3 reveals the research
methodology including conceptual framework, estimation method and variable
description to establish the econometric models based on the conceptual framework.
Third, chapter 4 presents data and the descriptive statistics, regression results and
discussions on the main findings of the study. Finally, chapter 5 expresses the

conclusions, policy implementations based on the main findings. In addition, this part
also discusses the research limitations and future development of the topic.

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CHAPTER 2: LITERATURE REVIEW

This chapter comprises the theoretical review and empirical review. First, literature
review is the summary of common theories of capital structure analysis such as
Modigliani and Miller theory, trade-off theory, and theory of agency costs. Then, on the
ground of on those above theories, empirical review give an overview of the contribution
of previous studies on the development of capital structure analysis.
2.1.

Theoretical literature review

Overall, there are many theories about firm’s capital structure. This study mentions three
theories: Modigliani and Miller theory, trade-off theory, and theory of agency costs.
Furthermore, key determinants of leverage would also be analyzed and summarized to
fortify the methodology and variables used in this paper.
2.1.1. Modigliani and Miller and capital structure theory (MM Model)
MM model is developed by Modigliani and Miller (1958) and is also named the modern
capital structure theory. It is based on these suppositions: (1) asymmetric information, (2)
no transaction costs, (3) there is no firm income tax, (4) without personal income tax, (5)
lending interest rate and borrowing interest rate are in consistent, (6) ability to have
funding of each individuals or firms is equal, (7) no bankruptcy costs and no financial
distress costs, (8) the whole return is shared for owners, there is no share of return for
investment.
In reality, the market is not similar to the assumptions; yet, two discoveries have the

significant impact from the consequence of Modigliani and Miller research. At first,
hypothesis of without taxation, this is chief discovery and the introduction for the
convenience of debt because of tax relief from interest expense. Next, Modigliani and
Miller theory with the finding of variability of cash flow induce the risk. This helps to
restrict the risk from mentioning cash flow in case of insolvency.
In core, MM theory is stated in two main propositions:
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(1) MM proposition I: Firm’s capital structure is not effect to the value of the firm
(2) MM proposition II: The cost of equity rises with leverage.
Each proposition is considered in turn into the hypothesis of tax and no tax. In the view
of no tax, the value of levered firm and value of unlevered firm are equivalent as the
formula: VU  VL , where VU is value of firm without debt is, VL is value of firm using
debt. Facing the different leverage level, the value of firms does not change. Thus, the
change of capital structure does not make the gain to shareholders. It means that the
capital structure is irrelevant.
On the other hand, at the view of having tax, firm value equals the value of unlevered
firm plus debt tax shields:
VL  VU  T * D

(2.1)

whereas, T is the corporate income tax, D is debt. The outcome of the above equation
explains the value of firm increasing by using debt. The value of a firm is increased by
rising debt to equity ratio (the famous MM proposition I).
Analyzing the impact of the changes of capital structure on the average cost of capital,
the MM proposition II concludes that the weighted average cost of capital will decrease
when the cost of equity increases with leverage. Nevertheless, MM theory ignores the
impact of some other costs such as financial distress costs. These financial costs reduce

the benefit of tax shield of firms increasing debt ratio. Facing this situation the financial
distress costs are higher than the tax shield; consequently, the optimal capital structure is
broken down (the point that the value of firm is maximized in condition of the weighted
average cost of capital minimized). At the point that the capital structure is higher than
the optimal level, the weighted average cost of capital is rising and the value of firm is
decreasing. The result is that gain from tax shield does not have enough magnitude to
compensate the financial distress cost. Therefore, firm may be fragile and face the status
of insolvency.
2.1.2. Trade-off theory
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In the view of trade-off theory, capital structure is established on the relationship between
debt and equity. There is a concept of “tax-bankruptcy trade-off” that a firm relies on tax
related gains from leverage to cover bankruptcy costs. In addition, the trade-off theory
proposes the idea that a company makes decision of capital structure by balancing the
costs and benefits. The advantage of debt finance is the debt tax shield while the
disadvantage is the agency costs and costs of financial distress, such as bankruptcy costs.
Bankruptcy costs including direct costs (legal and administrative expenses) and
indirect cost (cost incurred by a financial distressed firm and cost associated with process
to bankrupt or period of financial distress). When profitability decreases, expected
bankruptcy cost increase. There is a positive relationship between bankruptcy cost and
volatile earnings, this leads to less leverage toward smaller less-diversified firms.
In term of taxation, interest tax shield pushes the level of leverage higher. In contrast,
personal tax cost mitigates the rate of leverage. The negative relationship between the
marginal corporate tax saving and marginal personal tax cost affect the leverage level of a
firm. Fama and French (2000) express that tests of the DeAngelo and Masulis (1980)
model clearly display optimal leverage based on non-debt tax shields, that is, less
leverage toward higher level of non-debt tax shield. Besides that, the model also
discovers that higher expected payoff from the interest tax shields is paralleled with the

more profitable firm; but is related to less volatile earnings.
Adjustment (financing) cost - Financing cost include the transaction cost associated
with new equity and cost originated from management’s superior information about the
firm’s outlook and the value of its risky securities. A firm will set target leverage if
financing cost does not affect other factors. In contrast, Myers (1984) bases on the
assumption of asymmetric information problem and other financing cost that affect
optimal leverage in trade-off model. A firm would choose the level of leverage and
dividend payout under their no adjustment-cost optimal values. As a result, asymmetric
information and financing cost enhance the role of trade-off theory about target leverage
and dividend payout. The status of less leverage and lower dividend payout is for firm
with lower expected profits, higher expected investment and heavier volatility of net cash
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flow. The financing cost is not the main factor that affects the target ratio in the trade-off
model.
Financial distress
Assuming that firm is fixed in terms of assets and operations and only has the change in
debt-equity ratio, the static theory of capital structure reveals that the firms will borrow
up to the point where tax benefit from an extra dollar in debt is exactly equivalent to the
cost that comes from the increased probability of financial distress. Financial distress is
the situation that promises to creditors are broken. In finance, financial distress appears
when there are difficulties in making payment to creditors are broken. If the financial
distress can not be eased, firms will face to bankruptcy status. Financial distress often
combines with some costs that are defined as the costs of financial distress. It could be
legal and administrative costs for the lawyer in case of bankruptcy stage, higher interest
cost for lenders, accounting cost in case of losing staff, legal and administrative cost of
liquidation or reorganization, cost for customers against looking for other suppliers, costs
for keeping suppliers out of other projects outside firm. There is slightly effect of direct
costs of bankruptcy to firm value (Andrade and Kaplan,1998). Almeida and Philippon

(2007) confirm that the marginal distress costs can offset the tax benefit. In practice, it is
hard to measure the costs of financial distress that are open for debate.

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Figure 2.1. The optimal capital structure and the value of the firm
Source: Ross et al. (2012), page540, chapter 16, figure 16.6: The static theory of capital structure:
the optimal capital structure and the value of the firm

Figure 2.1 displays the trade off between tax savings from debt and financial distress
costs. VL denotes market value of firm. There are three situations in that Figure. The first
is the horizontal line extending from VU , this case of the firm value without capital
structure (MM proposition I without tax). The second is presented by the upward
slopping straight line (MM proposition I with tax ). The third is the case where market
value rise to a maximum and fall beyond that point (illustrating in this discussion). If debt
exceeds this point, financial distress cost increases. VL * is the maximum value of a firm
and D * is the optimal amount of borrowing. Comparing the third and the first case, the
benefit from leverage is net of distress cost. Examining the third case with the second
case, there is loss in value from the appearance of financial distress (Ross et al., 2012)
Firm’s assets mainly impact to costs of financial distress. If most of assets in a firm
are tangible assets, these assets can be easily sold without loss in value. There is the
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existence of incentive for this firm to reach high debt level. In contrast, firms that have
greater intangible assets such as employee talent or growth opportunities, there is no
incentive to borrow. The reason is that intangible assets could not be sold. In other words,
the tendency of borrowing more is favorable in firms with a lower risk of experiencing
financial distress compared with firms with greater risk of financial distress. Specifically,

Harris and Raviv (1990) declare that “firms with higher liquidation value, e.g., those
with tangible assets, will have more debt, will have higher yield debt, will be more likely
to default, but will have higher market value than similar firms with lower liquidation
value”. It means that the debt level is positively related to the liquidation in value. Cost of
distress is lower in the firm with higher liquidation. Andrade and Kaplan (1998) show
that hand costs of financial distress increase when leverage rises. They also find out the
magnitude of financial distress costs that get about 10 to 20 percent of firm value.
Briefly, firm could maximize firm value by forming financial leverage to the point
that the gain from tax shield on debt is offset by financial distress costs. The trade-off
theory accents the important of the target leverage. Firms have target leverage and
balance the leverage against target over time.
2.1.3. Theory of agency costs
Relating to agency stories of a firm, we mention about the different criteria between the
managers and owners. In reality, the interest of managers and security holders are not
always on the same direct, managers have a tendency to have bonus with the excess of
cash earnings over profitable investment. In every enterprise, the capital owners
(shareholders) have relationship with managers. Employees, especially managers, are
hired by the owners in order that the managers have responsibility to manage the firm
against receiving salary, other income. There is the existence of the relationship between
owners and managers (Jensen and Meckling, 1976). The firm manager is always interest
in maximizing their wealth. In contrast, the owner concerns in the value of company.
From that, there is the derivative of big conflict between firm’s managers and firm’s
owners. The manager sometimes does not complete the management role in the company.
In other words, manager does not care to the benefit of the owners (Eisenhardt, 1989).
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The agency costs are sourced from the contradiction of interest between managers,
shareholders and debtholders of the firm.
Jensen and Meckling (1976) also mentions to two kinds of conflicts. The conflict

between owners and managers is the first. The second is the conflict between managers
and creditors. The first appears due to the different viewpoint between management and
ownership in modern market. In this case, the owners could not control the managers and
the managers have more opportunity to enhance their benefit, simultaneously this leads to
the decrease in benefit of shareholders. Richardson (1996) claims that the bigger
contradiction is positively relates to free cash flow.
The second conflict is in the case of company using debt. At the aim of maximizing
firm value and upgrading firm, the owners need money to invest in new project. Creditors
lend owners of a company on behalf of managers to maximize profit of both. Owners also
agree with managers to manage projects in the high level of risk due to the greater profits.
The owners would receive all profits in the case of successful firm operating but the
creditors only receive the definite profit at the accrued interest. In contrast, if the firm
operates ineffectively, the creditor will loose from receiving the delayed principle and
lost the whole lent amount. In this case, lenders need gather members to monitor the
project disbursement. Costs derived from this situation are the agency costs that the
owners have to pay for using loan. Agency costs could be controlled by increasing the
management role, internal audit, regulations and the right of management board.
Jensen and Meckling (1976) reveal that debt is one of the main primary factors to
reduce the conflict between managers and owners. Using more debts disciplines the
managers due to fixed interest payment and limits the free cash flow that useful for the
managers. Jensen (1986) shows that the managers could not use cash in their own
purpose because of the obligation of paying interest payment. The firm’s agency costs of
free cash flow could be controlled by using financial leverage, dividends and managerial
ownership to restrict unreasonable spending of managers (Jensen, 1986). Debt and
dividends help control agency problem created by free cash flow by decreasing cash flow
to repay debt to avoid bankruptcy and by forcing manager to payout. This model predicts
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that firms commit a higher ratio of pre-interest earnings to debt payments and dividends

toward more profitable assets.
In line with agency cost theory, optimal capital structure is the case that cost of
agency related debt balances its benefit. Hypothesis of all things being equal, high debt
level is primary choice in firm with lower risky investments. Firms with high level of
growth opportunities haves less debt by reason of the unbearable status of paying debt
obstruct their reasonable investment in the future. If companies often have substantial
free cash flow at high level, it should limit the use of high debt to control management
role and to close managers’ faulty. And a high debt level is also accepted by creditors of
firms with great ability of liquidation.
2.2.

Empirical literature review

In the view of trade-off theory, capital structure is established on the relationship between
debt and equity. There is a concept of “tax-bankruptcy trade-off” that a firm rely on tax
related gains from leverage to cover bankruptcy costs. In addition, the trade-off theory
proposes the idea that a company makes decision of capital structure by balancing the
costs and benefits. The advantage of debt finance is the debt tax shield while the
disadvantage is the agency costs and costs of financial distress, such as bankruptcy costs.
The Modigliani and Miller (1963) investigate that tax benefit contribute to boost the firm
value in proportion to amount of debt used and diminish the cost of debt capital. That is
the MM debt tax shield hypothesis. The pecking order theory implies that firms have
priority in choosing of financing sources and follow the order of retain earnings, debt and
new equity. It is because asymmetric information has influences on the option of internal
or external financing and the choice of debt or equity issuing. Myers (1977) infers that
the trade off between the tax benefits of debt and cost of extra financial constraints and
bankruptcy leads the rise in firm’s leverage. Myers and Majluf (1984) find that managers
declare risky security in case of overpricing. However, this asymmetric information
absorbed to the investors lead to the under-value of risky securities. Therefore, managers
leave profitable investment for new risky securities. As a result, Myers gives conclusion

that the order choice of a firm for the investment is retailed earnings, safe debt, risky debt
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and equity at last. Pecking order theory means the internal financing being more
favorable.
Both two theories are useful ways of recognizing the usage of debt in a firm. The
trade-off theory introduce the guidance for capital structure in long run. The pecking
order theory is suitable for firm policy in shorter period, tendency toward investment by
external funds.
Recently, there are more concerns about the role of debt tax shield. Many researches
reveal that tax and debt tax shield significantly impact to firm’s financial leverage such as
MacKie-Mason (1990), Graham (1996, 1999), Gordon and Lee (2001), Xing (2015),
Hovakimian et al. (2001). Especially, the concrete investigation is that estimated value of
debt tax shield captures approximately 10 percent of firm value (Graham, 2000),
(Kemsley and Nissim, 2002) and (Vanbinsbergen, Graham & Yang, 2015). Thus, debt
tax shield becomes the extreme significant device for financial criteria (Schepens, 2015).
Debt tax shield is highly appraised by the impact of it to debt and the magnitude of debt
tax shield also depends on tax policy of each country.
Investigating how taxes affect to firm’s specifications is always the subject that
appeals many researchers. The prominent significant study belongs to Modigliani &
Miller (1958). Next, a stream of researches are Graham (1996a, 2000, 2003), Myers
(1984, 1998), Fama (2011), Princen (2012), MacKinlay (2015), DeAngelo and Masulis
(1980), MacKie-Mason (1990). All of these researches reach the significant level of tax
to firm specifications. Perceiving the role of corporate taxation and effective
implementation are the great trial in economics (Fama, 2011).
Gordon and Lee (2001) analyse debt policy in response to tax incentives by US
statistics of income balance sheet for 46 years from 1950 to 1995 on the whole to
compare the debt policies of firms of different sizes, specifically, small firms face
different tax rates than larger firms. Comparing to smaller firms, larger firms have a

tendency to finance 8 percent of their assets with debt. This study contributes to the
background of taxes leading large effect on debt

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Another research uses data in the time period 2001-2007 for the sample of Belgian
and French companies by difference approach to study the impact of taxation on capital
structure with the significant evidence at the rate of average 2 percent to 7 percent that
tax system promotes company to apply more debt than the existence of the equal tax
treatment of debt and equity (Princen, 2012).
MacKinlay (2015) finds that in the high interest tax environments, tax rate pushes big
effects on firms’ debt policy. Tax effects not only firms’ leverage but the elements
converged into debt as well. Thus, statutory provisions on tax would have little impact on
firms’ levevage policy.
The process to analyse the debt tax shield mostly includes three essential steps. First,
the use of debt is encouraged from the debt tax shield in the MM prediction. MacKieMason (1990), Trezevant (1992), and Graham (1996, 1999) have researches that
concentrate on incremental financing decisions. They conclude that high marginal tax
rates encourage the application of debt. Princen (2012) discovers that tax rate appeals
firm in using debt larger than the existence of the equal tax treatment of debt and equity.
Next, the firm value financial statement data is chosen to be the main factor to test the
debt tax shield (Graham, 2000). He predicts the mean corporate tax benefit of debt for a
large sample of Compustate firms. This is not a direct way to calculate the debt tax
shield, yet Graham confirm that firms get a tax advantage from applying debt.
The last inquiry of valuating the debt tax shield need to be mentioned is the direct
market signal about debt tax shield. Masulis (1980) induces the hypothesis of corporate
debt tax shield effect and discovers the wealth redistribution effect as a result of using
capital structure. Besides that, Fama and French (1998) apply cross sections to analyse
firm value on interest expense and on various controls for profitability. They discover a
strong negative relation between debt and firm value and conclude: "imperfect controls

for profitability probably drive the negative relations between debt and value and
prevent the regressions from saying anything about the tax benefits of debt" (p. 839).

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However, the above steps make an existence of confused status. This status is the case
that value of a firm’s operations is undetected, firm value could be correlated with debt
together nontax dimensions. These make the survey confounded.
Particularly, at the view of pecking order theory, the debt-intensive firms have lower
earnings growth conceivability than low debt-intensive firms. According to this theory,
the notion of using debt in profitable firms less than the unprofitable firms because of the
decrease in the value of operations. This decrease is caused by the financial distress costs
of debt, so debt is oustanding relating to the expected future operating profitability.
The approach of analyzing firm value on debt has disadvantage. The predictted value
of this approach could be distorted by unexpected bias of the operation value. Besides
that, this method could be bias due to the exclusion of market-based factors used to
restrain for risks and expected growth.
In a research of Liu, Nissim, and Thomas (2002) studying the valuation of equity by
using multiples, Kemsley and Nissim (2002) shows that Liu, Nissim, and Thomas (2002)
also discover the best measure of explaining current market value. This measure is
counted by the mean of consensus earnings for the next five years. In addition, Liu,
Nissim, and Thomas (2002) also displays that using earnings multiples for valuation is
more accurate than using free cash flow multiples because the appearance for lower free
cash flow in case of investing by growth trends.
In order to implement the research, Kemsley and Nissim (2002) introduce an
alternative approach rather than specifying firm value as a function of debt and imperfect
measures of future operating profitability. The author uses Compustat data to measure the
market value and use the future operating income (FOI) as the average operating income
for the five year that follow the current year in way of reversing the relationship. They

specify future operating profitability as a function of firm value, debt, and controls for
firm level capitalization rates. This method has two advantages. First, the future operating
profitability in the right hand side of the equation enables to exclude measurement error
to the regression residual that it does not correlate the debt coefficient; and helps to
supervise nontax information out of debt that effect to future operating income. Second,
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getting market value of firm out from the left hand side of regression pushes chance to
apply market based factors to supervise risk and expected growth.
Additional analysis, it is indeed to mention the role of state in the performance of state
owned firms; especially for country maintaining government involvement in business
corporations. Li et al. (2009) found that ownership concentration and state ownership are
negatively associated to the evidence of bankruptcy. There is advantage of state
ownership as the higher leverage, lower taxation, larger markets shares (Faccio, 2006) ,
but the author also showed the disadvantage of this kind of ownership as the high levels
of corruption, less clear system in the SOEs. Borisova et al. (2012) discovered that
government ownership generally leads to a higher cost of debt, consistent with
investment distortion fostered by state influence. Since the government guarantee
implicitly, default risk of the economic recession or firm distress are solved by the
dominant effect of government. The higher cost of interest of lenders will push financial
distress higher. The advantage and disadvantage influence to performance of state
ownership enterprise is known as double-edged sword. Huang et al. (2011) revealed the
positive relationship between state ownership and debt ratio. The explanation of this
positive interact belongs to three things. First, on the background of the low probability
of bankruptcy, they have substantial advantages with respect to enter to debt market.
Secondly, to preserve control and dominance, representatives of state ownership have
priority for high level of debt instead of shares. Thirdly, firm with high level of state
ownership has segregation between voting and cash flow rights, agency problem become
more complicated between owners and managers. The real owners of state owned shares

are the citizens; in contrast the decision in firm is depended on government departments
whose income is not determined by their control through firm performance. There is no
motivation to urge to the effective operation of a firm. As consequence, state owned firms
prefer high debt to diminish agency costs of equity. Another advantage of state control is
mentioned, while private firms must bear high cost on capital sources, state owned firms
receive a preferential treatment of state owned banks with low cost of loan. The
prominence of SOEs is that banks support favorable loan for them because they might be
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able to build up political connections with politicians to obtain lucrative contracts (Butler
et al., 2009). Lin and Tan (1999) also showed that SOE receive fund from state owned
banks regardless of risks but they do not have to fully cover expenses from sales and
income, the government often bears the losses of unprofitable SOEs. This is also the
claim for the prominence of debt usage in firms with high state ownership than others in
the research of Poyry and Maury (2010) on 95 listed Russian firms from 2000 to 2004.
From above preferential treatment, state ownership enterprises tend to use more debt
than other ownership firm. This means that the magnitude of debt tax shield in SOEs will
be larger than other kind of ownership. The more debt usage is the more financial distress
is. High leverage leads to an increase in hand costs of financial distress (Andrade and
Kaplan, 1998). Ding et al. (2007) concluded that theory agency originated from different
concerns of many levels of agents conflict with each other because the government is
both the regulator and the manager. In adjusting the policies to deal with financial
distress, private firms are faster than state own firms. Almeida and Philippon (2007) used
credit spreads to value distress costs and concluded that there is the apparent reluctance
of firms to have higher their leverage, in spite of the benefit from debt tax shield.
Before starting the study in details, we all together review the context about Vietnam
economy as followings. In 1986, Vietnam reforms the economy as known as “DOIMOI”
policy that creates a high jump in VietNam economy by change from a centrally planned
economy to a market oriented economy. During liberalization process, a State-Owned

Enterprises (SOEs) reform program is implemented in 1992 at the purpose of activating
the private ownership policy. Equitization is the main core of reform program.
Specifically, the regulation shows that the ownership over 50 percent shares of
government is known as state-owned company. Sectors as airlines, electricity and
telecommunication are still restricted by status of government control. The next step in
the liberalization process stock market has been established. The first stock exhange
named Ho Chi Minh Stock Exchange (HOSE) has offically operated on 20 July 2000 and
the next stock exchange named the Hanoi Stock Exchange (HNX) has openned on 8
March 2005. The operation of stock exchange establishes the active tendency for the
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developing of the economy and creates a high jump for firms in capital mobilization,
especially for medium and small enterprises. From that, small and medium enterprise
plays an important role in the economy.
The application of private ownership stimulates the market more competitive and
effective. If the enterprise operates effectively, the owner has profit. In contrast, the
uneffective operation of firms leads owner being loss. Maximize the value of firm and
minimizes the cost of capital are the main purpose of a firm. There are bodies of
researches to find out the best way for purpose of maximizing profit. The notion of using
debt is one of approaches in financial decision. In Vietnam, some authors study the firm
performance and internal factors such as Nguyen and Nguyen (2012), Tran and
Neelakantan (2006), Tran and Tran (2008) and Nguyen et al. (2012). Tran and
Neelakantan (2006) study the capital structure in small and medium size enterprise in the
period 1998-2001. This research concludes that short term liabilities are priority in firm
financial decision. Tran and Tran (2008) research on capital structure and firm
performance listed on Ho Chi Minh stock exchange with 50 non-financial listed firms.
The result is that the firm performance has the negative relationship with leverage when
D/E ratio was more than 1.812. Thus firm performance has the positive relationship with
leverage. Firm should increase the debt ratio to raise the firm value. Another research on

the effect of capital structure on 92 Vietnam’s seafood processing enterprises from 2005
to 2010, Nguyen and Nguyen (2012) result that firm value and financial leverage have a
non-linear relationship that are consistent with the study of Chou and Lee (2010).
Specifically, the Vietnam’s Seafood processing firm would be nearly optimal against the
debt ratio less than 59.27 percent. Nguyen et al. (2012) find that there is negative
relationship between leverage and profitability. It is recognized that there is limitation of
the study about Vietnam capital structure and elements relating to financial decisions.
Indentifying the benefit of company’s capital structure and suitable implementation
have become more and more important in financial economics. Specially, the benefit
from the deductibility of interest expense in taxing, in other words debt tax shield is
always a remarkable problem. Interest tax shield pushes the level of leverage higher. In
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