Foreign capital flows and stock market – case study in vietnam for foreign investors’ decision of trading and their ownership

UNIVERSITY OF ECONOMICS

INSTITUTE OF SOCIAL STUDIES

HO CHI MINH CITY

THE HAGUES

VIETNAM

THE NETHERLANDS

VIETNAM – NETHERLANDS
PROGRAMME FOR M.A IN DEVELOPMENT
ECONOMICS

FOREIGN CAPITAL
FLOWS AND STOCK
MARKET – CASE
STUDY IN VIETNAM
FOR FOREIGN
INVESTORS’
DECISION OF
TRADING AND
THEIR OWNERSHIP
A thesis submitted to Vietnam – Netherlands
Program in partial fulfillment
of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT
ECONOMICS
By

Ngo Van Man


Supervisor
Dr. Nguyen Trong Hoai

HO CHI
MINH CITY,
January 2013


ACKNOWLEDGEMENTS
I am not able to finish this thesis without the guidance of my supervisors and
committee members, supports from my classmates and colleagues as well as
motivation and sharing from my wife.
I would like to express my very great appreciation to my supervisors, Dr. Nguyen
Trong Hoai and Dr. Nguyen Xuan Thanh, for their patient guidance, enthusiastic
assistance, valuable comments and suggestions as well during my research. I also
would like to take this change to thank Dr. Nguyen Tan Thang for his ideas inspiring
me to pursuit this topic for my thesis. I highly appreciate staffs of the Administration
Department and Library of Vietnam-Netherlands Program and my classmates in
providing me good environment , facilities and supporting me technically to complete
the thesis.
Finally, I would like to express my love and gratitude to my wife and colleagues
for their understanding, supports, and encouragements to finish the research.


TABLE OF CONTENTS
CHAPTER 1: INTRODUCTION.............................................................................1
1.1

Problem Statement:........................................................................................1

1.2

Research questions:.......................................................................................1

1.3

Research objectives:......................................................................................1

2.1

Economic theories:........................................................................................2
2.1.1 Definition of key concepts:..................................................................2
2.1.2 Relationship between foreign investor and firm characteristics..........3

2.2

Related empirical studies:..............................................................................5

2.3

Conceptual framework:................................................................................. 6

3.1

Research context:...........................................................................................7

3.2

Source of Data and its definition:..................................................................7

3.3

Research Methodology:.................................................................................9

4.1

Descriptive Data Analysis...........................................................................10
4.1.1 Summary of Data:..............................................................................10
4.1.2 Correlation Matrix..............................................................................13

4.2

Empirical Results:........................................................................................13
4.2.1 For the whole sample :.......................................................................13
(a) Firm characteristics and foreign investor’s buying volume:..............13
(b) Firm characteristics and foreign investor’s selling volume:...............14
(c) Firm characteristics and net purchase variable in relation to foreign

investor’s ownership ratio.......................................................................................14
4.2.2 For specified industries:.....................................................................15
(a) Finance Industry..................................................................................15
(b) Construction Industry..........................................................................16
(c) Manufacturing Industry...................................................................... 17
5.1

Conclusions..................................................................................................18
5.1.1 Empirical results.................................................................................18

5.2

Policy recommendation:..............................................................................19
5.2.1 For investors:......................................................................................19
5.2.2 For companies:...................................................................................19
5.2.3 For government authority:..................................................................19

5.3

Limitations and Further research.................................................................20


5.3.1 Limitations:........................................................................................20
5.3.2 Further research:.................................................................................20
REFERENCES:...................................................................................................... 21
APPENDICES:....................................................................................................... 24


LIST OF TABLES
TABLE
Table 2.1: Summary of related empirical studies as following
Table 2.2: Summary of Expected signs
Table 3.1: Viet Nam Stock Market capitalization
Table 3.2: The structure of industry in dataset
Table 4.1:Description of variables of the whole sampled stocks
Table 4.2: The summary of value traded of the whole sample
Table 4.3: Percentage of FDI and Portfolio inflows over GDP in Viet Nam
Table 4.4: The summary of statistics by mean of each industry
Table 4.5: The coefficient signs between buy-volume with other variables

Table 4.6: The coefficient signs between sell-volume with other variables
Table 4.7: The coefficient signs between ownership ratio with other variables
Table 4.8: The coefficient signs for finance industry
Table 4.9: The coefficient signs for construction industry
Table 4.10: The coefficient signs for manufacturing industry


ABSTRACT.
Foreign capital flow in empirical studies has recently recovered into the developing
countries and emerging markets. Their impact on growth of such countries has
empirically increased and also created some negative temporary effects. Foreign
direct investment positive correlates to growth, meanwhile portfolio investment seems
to be negative correlated with it. One of such effects through stock market is blamed
for the crisis. This paper aims to evaluate how firm’s characteristics affect to foreign
investors in their investment both in buying and selling decision into listed firms in
Vietnam stock market and to figure out their longer positions after that.
Keywords: foreign investors, stock market, firm characteristic


CHAPTER 1: INTRODUCTION
1.1 Problem Statement:
Financial integration has so far benefited to not only source countries but also host
countries. One of those benefits is to increase in investment in which capital flows from
the capital-abundant places to hosts especially in developing countries.
As a matter of fact, in order to diversify risks in foreign investment as well as to cover
the more often crisis in the global economy many hedge funds have also set up and
operated to meet such trends. Actually, portfolio investment inflows, together with
foreign hedge funds, were blamed for the crisis.
This paper aims to study the relationship between foreign investors’ investment
decision and the stock market via volume of trading of foreign investors in Viet Nam

specified to those stocks heavily traded by foreign investors. Therefore, this paper also
helps to provide investors both domestic and foreign investors an adequate understanding
about types of companies attractive the foreign investor’s decision of buying or selling as
well as their long term position via ownership ratio.
1.2 Research questions:
The final purpose of this paper is to answer the following questions:
(i)

Do foreign investor’s buying and selling decisions really focus on stocks of large

companies with better profitability?
(ii)

How do their buying and selling volume affect to their ownership ratio?

1.3 Research objectives:
The overall objective of this paper aims to evaluate which firm’s characteristics affect to
foreign investors’ decision of selling and buying as well as to their ownership ratio for
long term position. Subsequently, the paper will further clarify them for each related
industry.

1


CHAPTER 2: LITERATURE REVIEWS
2.1 Economic theories:
2.1.1 Definition of key concepts:
(a) Foreign capital flows

Typically, foreign capital flows into the host countries especially into developing and

emerging ones in three channels: foreign direct investment, portfolio investment and
foreign debt. Theoretically, foreign direct investment flows into two ways: Greenfield and
Merge & Acquisition activities which have been significantly increased in emerging
markets (World Economic and Social Survey 2005). Portfolio investment in other hand
includes equity securities or debt securities in forms of bonds, money market instruments,
and financial derivatives.
Investors in country A could invest in country B or vice versa to seek for
diversification in their portfolios in term of risk (balancing their portfolios) and expected
(equity) return.
(b) Foreign investment in relation to stock market

In many empirical studies, Foreign Direct Investment has also significantly and positively
affected to domestic stock market development. (Adam and Tweneboah). FDI which was
found to be a complement of stock market development has positively correlated with
market capitalization and domestic value traded. (Claessens et al.,2001). Furthermore,
along with the more global integration in finance market, foreign investment in portfolio
investment has been empirically found increasing with its certain advantages such as a
high mobility in flowing out and in markets as well as to reduce some existing limitations
in the bond market in developing and emerging markets.
In short, foreign investors always seek for investment opportunities. In other words,
foreign investment flows from firms with low investment opportunities to firms with high
ones. However, an average return of some types of investors’ portfolios appears rather
differentiated in which some investors actually want to own stocks or firms for specified
objectives such as their business relationship and control rather than a high investment
return (Kim et al, 2005).

2


(c) Firm characteristics: Financially, analyzing firm characteristics concentrates on ratio

analysis. According to Ross et al. (2005;2010), ratio analysis is often classified into
following groups: Market value measures; Profitability Measures; Short term solvency or
liquidity measures; Long term solvency measures; and asset management or turnover
measures.
The paper will mainly focus on four of five above groups including market value,
liquidity, profitability and long term solvency measures. Furthermore, the paper will also
take account of dividend policy because this policy along with others will affect to firm’s
ability to sustain growth (Ross et al.,2005;2010).
2.1.2 Relationship between foreign investor and firm characteristics
According to Baker et al. (2009), FDI flows are much affected by components of stock
evaluations which have been used to reflect mispricing specially in presence of capital
account restrictions to limit arbitrage by portfolio investors.
a) Relationship between foreign investor with market value measures:

Market capitalization has empirically a strong relationship with stock returns of foreign
investors’ investment. Due to redemption and liquidity requirement for foreign
investment as well as to prevent systematic risk, foreign investors prefer large market
capitalization firms.
Some studies demonstrated that foreign investors tend to prefer large market
capitalization and strong financial firms (Kang and Stulz,1997; Lin and Shiu,2001; and
Kim et al.,2005). On the contrary, other studies show a negative relationship that on
average, smaller-size firms get higher stock returns than large-size firms (Banz,1981;
Keim,1983 and Basu,1983).
In regard to PB and PE ratio, some showed a negative relationship between PB ratio
and stock returns ( Fama and French,1992; Daniel and Tittman, 1997). Hence, foreign
investors can gain higher stock returns as they buy low PB stocks (Dhatt Kim and
Mukherji,1999). On the contrary, others demonstrated that foreign investors prefer stock
with high PB ratio (Lin and Shiu,2001 ; Kim et al.,2005; and Bae et al.,2011).
In regard to PE ratio, this is considered to be the single most important variable in

determining a share’s price. As a matter of fact, Basu (1977), Breen (1978) and Dreman
3


(1980a,1980b,1979) demonstrated that stocks with low PE ratio can gain a higher average
returns than those with high PE ratio. However, some recently empirical studies found
that foreign investors tend to buy stocks outperformed and sell stocks underperformed
relative to the market (Bae et al.,2011)
b) Relationship between foreign investor with Profitability Measures:

According to Kim et al. (2005), there has been a positive correlation between foreign
ownership and ROE ratio which was considered to be an important variable to foreign
investors. Similarly, Bae et al. (2011) found that foreign investors traded stocks in Korean
listed companies with high ROE and ROA ratio in which not only for the same current
period but also for the subsequent period, their “buy” stocks have higher profitability
than their “sell” stocks. Furthermore, Kang et al.(2010) in studying firms listed on
Korean Stock Exchange also demonstrated that corporate profitability measured by the
EBITDA has positively correlated with foreign ownership.
c) Relationship between foreign investor with liquidity measures:

According to Kang et al.(2010), liquidity ratio has positively correlated with foreign
ownership into Korean Stock Exchange listed companies. However, Vo Xuan Vinh
(2010) found that liquidity ratio has negatively correlated with foreign ownership for
firms listed on Ho Chi Minh Stock Exchange.
In other words, foreign investors seem to follow a buy and hold strategy for their long
term position rather than for short term.
d) Relationship between foreign investor with financial leverage ratio:

Many empirical studies revealed that foreign investors favor firms with low debt
ratio. (Kang and Stulz, 1997; Lin and Shiu,2001; Kang et al.,2010 and Vo Xuan Vinh,

2010). In other words, foreigners prefer firms with low leverage ratio as well.
Meanwhile, Bae et al.(2011) studied and found that firm leverage is not an important
variable affect to foreign investor’s decision of buying or selling. This is also consistent
with the finding of Mishra and Ratti (2011).
e) Relationship between foreign investor with Dividend Policy:

Besides preferring large-size firms , foreign investors were found to prefer stocks with
high dividend yield (Jeon et al., 2010; Mishra and Ratti, 2011 and Bae et al.,2011).
4


Meanwhile, Dahlquist and Robertsson (2001) found that foreign investors also prefer
stocks of lower paid-dividend firms.
2.2 Related empirical studies:
Table 2.1: Summary of related empirical studies as following table:
Authors

Observations

Lin and

Firms in Taiwan

Shiu

Stock.E ( 1996-

(2003)

2000)

Firms in Korean

Kim et al.

(1993-2002)

(2005)

Tokyo (19862001) Stock.E

Pimnara
Hiranka
si (2008)

Vo
Xuan
Vinh
(2010)

Bae et
al.
(2011)

20 stocks in
Thailand stock
Market (19992003)

firms listed on
HOSE (20072009)

Daily trading in
Korean Stock
Market (19962000)


5


2.3 Conceptual framework:
FIRM’S CHARACTERISTICS:
1. Market Value
Market Capital (VND billion)
PB (x)
PE (x)
2. Profitability
ROE (%)
ROA (%)
EBITDA
3. Liquidity
Current Ratio (times)
Quick Ratio (times)
4. Financial leverage
Debt to equity ratio
5. Dividend Policy
Dividend per Share (VND)

All expected relationships among variables could be likely summarized as the
following tables:
Table 2.2: Summary of expected signs:

6


CHAPTER 3: RESEARCH METHODOLOGY
3.1 Research context:
Established and operated since 2000 for Ho Chi Minh Stock Exchange (hereafter HSX)
and since 2005 for Hanoi Stock Exchange (hereafter HNX), role of stock market in
mobilizing capital for the whole economy was very impressive and indispensable with
their yearly percentage of the total volume over GDP as the following table. Table 3.1:
Viet Nam Market capitalization
Vietnam stock Market capitalization (%GDP)

2007
% GDP

Source: Word Bank – Global Financial Data
3.2 Source of Data and its definition:
Firstly, the research will select data from 2007 to 2011 just because only from 2006
onward the total volume trading by foreign investors has significantly increased.
Secondly, the paper will focus on listed stocks of three main industries in HSX and
HNX as described above including Construction and Real Estate, Manufacturing and
Finance and Insurance which have listed from 2007 backward and their market
capitalization for finance industry over VND 100 billion (as of July 13, 2012) and
reported the foreign trading generated. This sample of more 98 listed firms and observed
over 05 years will therefore turn out over 420 observations with their structure as
following:


7

Table 3.2: the structure of industry in dataset(as of July 13, 2012)

Source: Author’s calculate on the data set
Firm characteristics:
(i) Market Capitalization (MKC): this variable is the market capitalization of each firm at

the year-end.
(ii) Dividend paid (DIV): how much dividend actually paid to each shareholder.
(iii) Price Book ratio (PB): A ratio of a listed firm’s book value to its market value. It

determines how the market prices a company relative to its actual worth and measured by
market value divided its book value.
(iv) Price Earning ratio (PE): a share price divided by earning per share
(v)

Return on Equity (ROE): Net income divided by the book value of equity at year

end.
(vi) Return on Asset (ROA): An indicator to measure how profitable a company is

generated from the invested capital (assets)
(vii) Earnings before Interest, Taxes, Depreciation and Amortization (EBITDA). This

indicator is used to eliminate the effects of financing and accounting decisions and
therefore to analyze and compare profitability among selected companies better.
(viii) Ownership rate (OWN): measured how many percent of shares hold by foreign

investors. As required by Foreign Investment Laws the maximum room available for

8


foreigners to invest into each company is not higher than 49%. This requirement affects
so much to foreigner’s decision of trading.
(ix) Debt to Equity Ratio.(DEBT): defined by total liabilities divided total equity often

at year end
(x)

Current Ratio (C_Ratio): measures a company's ability to pay short-term obligations

calculated by current assets divided by current liabilities
(xi) Quick Ratio (Q_Ratio): is calculated as (Current Assets - Inventories) / Current

Liabilities
3.3 Research Methodology:
The estimated equation is a linear regression model as follows:
Yi,t = αi + X j, i , t β + εit (*)
In where:
- YI,t denotes buying, selling and ownership ratio for firm i at trading year t
- XJ, I, t presents the firm characteristic variables j of firm i at year t which are divided into

stock characteristics including MKC, PB, P/E ratio, ROE, ROA, EBITDA , DEBT ,
C_Ratio, Q_Ratio or Dividend Yield .
- αi are random individual-specific effects, β is a vector of our robust estimators; and ε

is a error term;
The paper will employ the panel data which have advantages over pooled data. In order

to select the most appropriate models for specified samples, the paper will test all
possible regression models including: Fixed-Effects Model (also called Least Squares
Dummy Variable Model); Random-Effects Model (or Random Intercept, Partial Pooling
Model); Pooled model or population-averaged model.
After finalizing the appropriate model, to control for heteroskedasticity the option
“robust” will be employed in regression. Finally, in order to detect the likely
multicollinearity among variables the paper will use the variance inflation factor after
regression model. Such tests will be easily found in the appendix of this paper.

9


CHAPTER 4: DATA ANALYSIS AND DISCUSSION
4.1 Descriptive Data Analysis
4.1.1 Summary of Data:
Table 4.1: Description of variables of the whole sampled stocks:

Industry
Construction

Finance

Manufacturing

Total
Source: Author’s calculate on the data set with Stata software.
Market capitalization of the finance industry is the highest; the construction and
manufacturing industry followed as the second and third of market capitalization. In
addition, stocks of construction field were priced at the highest mean value at 25 times,
followed by stocks of finance and manufacturing at 15 and 11 times, respectively.

In general, foreign ownership ratio at firms surveyed in three industries is not much
different at 20% of both finance and manufacturing industry and 17% of the construction
industry. And the mean of debt ratio in the construction field is extremely high at 2.35
times followed by manufacturing and finance industry at 1.33 and 0.66 times,
respectively.


10


Table 4.1: Description of variables of the whole sampled stocks (continued):
Industry
Construction

Finance

Manufacturing

Total

Source: Author’s calculate on the data set with Stata software.
Table 4.2: The summary of volume and value traded of the whole sample

Source: Author’s calculate on the data set with Stata software.
In compared to net inflows of portfolio equity into Viet Nam as the following table
(table 4.3), it revealed a meaning fact that a large net inflow of portfolio equity flowed in
Viet Nam accounted for 2.24% of GDP in 2010. The year with the reported average PE
ratio of the whole sample was lowest at 10 times (table 4.4). In other words, stocks in
2010 were cheapest during five years.

11


Table 4.3: Percentage of FDI and Portfolio inflows over GDP in Viet Nam
Indicator
Foreign direct investment, net inflows
(% of GDP)
Portfolio equity, net inflows (% of GDP)

Source: World Bank - Global Financial Data
In short, Vietnam stock market as being underpriced seemed always to be attractive to
foreign capital inflows, especially in term of portfolio equity inflows. To get a clearer
overview of variables over year, the following statistics of mean of variables during five
years could exhibit their likely trend.
Table 4.4: the summary of statistics by mean of each industry:
Industry
Construction
Finance
Manufacturing
Total
Industry
Construction
Finance
Manufacturing
Total
Industry
Construction
Finance
Manufacturing

Total
Industry
Construction
Finance
Manufacturing
Total

Source: Author’s calculate on the data set with Stata software.

12


4.1.2 Correlation Matrix
Finally, from the correlation matrix of variable (see Appendix 5) , at a glance we can
see except that coefficients between ROE and ROA; Quick and Current ratio have a high
correlation, other correlated coefficients among variables are not high. Hence, the
regression model will take account into multicollinearity among such variables.
4.2 Empirical Results:
4.2.1 For the whole sample :
(a) Firm characteristics and foreign investor’s buying volume:

Table 4.5: The coefficient signs between buy-volume with other independent variables:
Buy volume Whole sample

(*** and ** present statistical significance level at lower 5% and 10%, respectively)
It can infer that foreign investors tend to buy value stocks of large firms in finance
and construction industry with better performance and low financial leverage. And for all
industries they decrease their buying volume for firms with high debt ratio. Such findings
are almost consistent with previous empirical studies.

13