(Luận văn thạc sĩ) determinants of leverage case study of vietnam seafood processing and exporting industry both for listed and unlisted firms

UNIVERSITY OF ECONOMICS
HO CHI MINH CITY
VIETNAM

INSTITUTE OF SOCIAL STUDIES
THE HAGUE
THE NETHERLANDS

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

DETERMINANTS OF LEVERAGE: case study of
VIETNAM SEAFOOD PROCESSING AND EXPORTING
INDUSTRY both for listed and unlisted firms

By
PHAM THI TRUC LAM
A thesis submitted in partial fulfillment of the requirements for the degree of
MASTER OF ARTS IN DEVELOPMENT ECONOMICS

Academic Supervisor:
Assoc. Prof. NGUYEN TRONG HOAI

HO CHI MINH CITY, DECEMBER 2012


CERTIFICATION
;;

"I certificate that the substance of the thesis has not already been submitted for any
degree and is not currently submitted for any other degree.

I certify that to the best of my knowledge and help received in preparing the thesis
and all sources used have been acknowledged in the thesis."
Signature

Pham Thi True Lam
Date .................. .

.

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ACKNOWLEDGMENTS
=

First and foremost, I would like to send my dearest thank to my supervisor, Assoc.
Prof. Nguyen Trong Hoai for his guidance and support.
In addition, I would also like to express my gratitude to all persons and
organizations for their support, provision of assistance and information that made
this thesis possible. I am also grateful to the lecturers and staff of the project who
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helped improve my knowledge and fulfill the programme .
Finally, I am greatly indebted to my family for their love for and support of me,
keeping me in good condition for learning. I am also grateful to my close friends for
their warm encouragement.

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ABSTRACT

Although there are many prior studies about leverage as well as capital
structure on the world in general and Vietnam in particular, results of these
researches are still inconsistent. Moreover, in context of Vietnam, most of studies
about leverage are of listed firms. So, this study works with data of both listed and
unlisted firms. The purpose of this study is to examine the relative importance of

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some factors to the leverage of Vietnam seafood processing and exporting
enterprises. A sample of 20 listed and 15 unlisted enterprises for a period of 3
years from 2009 to 20 11 was chosen and tested base on pecking order theory and
trade off theory. The results finding from the thesis is that firm growth
opportunities and firm size have positive related to leverage, profitability, liquidity
have a negative effect to leverage whereas tangibility assets and non-debt tax
shield have no impact on leverage of Vietnam seafood processing and exporting
enterprises.
Key words: leverage, pecking order theory, trade off theory

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CONTENTS
Certification ........................................................................................................................... i
Acknowledgement ................................................................................................................. ii
Abstract ................................................................................................................................. iii
Contents ................................................................................................................................ iv
List of Tables ......................................................................................................................... vii
List of Abbreviations ............................................................................................................. vii

CHAPTER I: INTRODUCTION FOR THE STUDY ........................................................ 1
1.1 Problem statement: .................................................................................................... 1
1.2 Research objectives: .................................................................................................. 3
1.3 Research questions: .................................................................................................... 3
1.4 Research Methodology: ............................................................................................. 3
1.5 Structure of the thesis: ............................................................................................... 4
CHAPTER II: LITERATURE REVIEW FOR DETERMINANTS OF LEVERAGE ...... 5
2.1 Key Concepts: ............................................................................................................ 5
2.2 Related theories: ........................................................................................................ 6
2.2.1 The Modigliani-Miller theorem: ......................................................................... 6
2.2.2 Agency cost theory: ............................................................................................ 7
2.2.3 Trade-off theory: ................................................................................................. 8
2.2.4 The pecking-order theory: ................................................................................... 8
2.3 Determinants of leverage: ........................................................................................ 10
2.3.1 Leverage and Profitability: ................................................................................ 12
2.3.2 Leverage and firm size: ..................................................................................... 13
2.3 .3 Leverage and Firm Growth: .............................................................................. 15
2.3.4 Leverage and Non-debt tax shield : ................................................................. 16
2.3.5 Leverage and tangible assets: ............................................................................ 17
2.3.6 Leverage and liquidity: ..................................................................................... 19
2.4 Empirical review on determinants of leverage: ....................................................... 20
2.4.1 Empirical evidences finding from the world: ................................................... 20

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2.4.2 Empirical evidences finding from Vietnam perspective: .................................. 24
2.5 Chapter remarks: ...................................................................................................... 25
CHAPTER III: RESEARCH METHODOLOGY ............................................................. 27
3.1 Data and variables description: ................................................................................ 27

3.1.1 Data: .................................................................................................................. 27
3 .1.2 Description of variables: ................................................................................... 27
3.2 Methods of estimation: ............................................................................................ 29
3.2.1 Ordinary Least Squares (OLS) estimator: ......................................................... 30
3 .2.2 Fixed Effects (FE) estimator: ............................................................................ 31
3.2.3 Random Effects Estimator (RE): ...................................................................... 32
3.2.4 Hausman specification test: .............................................................................. 32
3.3 Hypotheses ............................................................................................................... 33
3.4 Chapter remarks: ...................................................................................................... 33
CHAPTER IV: OVERVIEW OF SEAFOOD PROCESSING AND EXPORTING
ENTERPRISES ................................................................................................................. 3 5
4.1 Introduction of the seafood export industry: ........................................................... 35
4.2 Analysis of capital structure of the seafood enterprises: ......................................... 38
4.2.1 Debt to equity ratio: .......................................................................................... 38
4.2.2 The equity growth rate: ..................................................................................... 41
4.3 Chapter remarks: ...................................................................................................... 42
CHAPTER V: EMPIRICAL RESULTS ........................................................................... 43
5.1. Descriptive statistics ............................................................................................... 43

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5.2 Analysis of the correlation between all variables: ................................................... 44
5.3 Test multicollinearity: .............................................................................................. 45
5.4 Empirical results: ..................................................................................................... 46
5.4.1 OLS estimator: .................................................................................................. 46
5.4.2 Hausman specification test: .............................................................................. 48
5.4.3 Fixed effects estimator: ..................................................................................... 49

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5. 5 Chapter remarks: ...................................................................................................... 53
CHAPTER VI: CONCLUSION, POLICY RECOMMENDATION AND
LIMITATION .................................................................................................................... 55
6.1 Conclusion ............................................................................................................... 55
6.2 Policy recommendation ........................................................................................... 57
6.3 Limitation and suggestion for further study: ........................................................... 61
Reference ...................................................................................................................... 62
Appendix ...................................................................................................................... 68

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LIST OF TABLES

Table 2.1: Summary of leverage determinants

Table 3.1: Variable, description and its expected sign
Table 4.1: The equity growth rate
Table 5.1: Descriptive statistics of sample variables
Table 5.2: Correlation coefficient matrix
Table 5.3: Result of auxiliary regression models of each dependent variable
Table 5.4: Result ofOLS estimator
Table 5.5: Result ofHausman test
Table 5.6: Result of Fixed effects estimator

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LIST OF ABBREVIATIONS

NDTS

Non debt tax shield

SEAs

Seafood processing and exporting enterprises

SMEs

Small and medium enterprises

FE

Fixed effects

RE

Random effects

GDP

Gross Domestic Product

GSO

General Statistics Office of Vietnam

OLS

Ordinary Least Square

STD

Short term debt

LTD

Long term debt

TTD

Total debt

EQTY

Equity

ASS

Total assets

Vlll


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CHAPTER 1: INTRODUCTION FOR THE STUDY
This chapter will explain the reason for choosing the thesis, its objectives
and research questions. In addition, this part also presents a brief of methodology
and finally abbreviates the structure of the thesis.
1.1 Problem statement:

One of the most important decisions confronting a firm in corporate finance
is the design of its capital structure. In order to finance for investment, the firms
can choose either internal or external funds. Internal fund is the firm retained
earnings whereas external fund can be raised from issuing equity or taking debt.
Sometimes, firms may take too much or without taking debt. An effective debt

ratio or leverage should not only help reducing the weighted average cost of
capital of the firm but also it still can increase firm value. To decide how much
leverage the firm should take on, the firms need to know which factors affect
leverage. However, over 50 years since the first research of Modigliani and Miller
(1958) about leverage, the question of them about what factors affect leverage are
still unresolved until now. This seems to be the most enigmatic and interested
issue of many researchers. However, until now, the effort of researchers to solve
the debt equity choice also does not bring results that satisfy all of them. The
results are still inconsistent between researches at different countries and different
industries. Moreover, Myers ( 1984) also suggests that "the average debt ratio will
vary from industry to industry because asset risk, asset type and requirements for
external fund also vary by industry" (p.578). In case of Vietnam, there are also
some studies testing for determinants of the leverage of Vietnam companies, such
as Nguyen and Ramachandran (2006), Dzung et al. (2012) and the empirical
results of these studies also contain conflicts as results from many other studies in
the world.

.

Seafood is considered to be one of major industries and one of the key
export sectors of Vietnam. Each year, it contributes largely to GDP. Particularly,

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in year 2011, total value of seafood product is 99.432 billion VND, contributes
about 4% to GDP (Source: GSO 2011 ). Vietnam has many outstanding advantages

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in the industry to develop this field as high position in most leading markets,
diversified channel of distribution, large farming area with lot of species of
seafood .... However, with many changing about interest rate through past these
years, many seafood enterprises have been affected strongly as most of their
sources of capital are loan from bank. In year 2009-2010, in order to support for
firms in time of difficulties of the economy in Vietnam as well as the world
economy crisis, the Government loosed monetary policy. However, this forced
credit growth become too high, leaving far growth of GDP. This created unbalance
and pushed up inflation rate. Therefore, by the year 2011, to control inflation, the
Government has employed tightening monetary policy through controlling credit
strictly and limiting in supplying money for the economy. Commercial banks
become short of fund to finance for trade. According this context, loan interest rate
increase and conditions to be approved for lending from bank are also more
serious. This makes a lot of enterprises hard to reach of loan capital. Together with
many other difficulties of seafood firm as lacking of source of material, higher
cost of input, decreasing of export market, lacking of capital lead many seafood
firms to a more difficult situation, even more a lot of firms must go bankrupt. Only
at the beginning of the year 2012, 470/800 exporting seafood firms must stop
working, not exclude large companies. The problem is these enterprises depend
too much on debt while the way of using debt is ineffectively. So, now
restructuring of capital structure become the most important problem for Vietnam
seafood enterprises. To improve financial ability and avoid risk of financial,
seafood enterprises need to have a suitable leverage. In order to do that, it's very
important for firms to know whether leverage of firms may be impacted by which
factors. Finding factors affecting leverage will help enterprises to control its
leverage through impacting on these factors.

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1.2 Research objectives:

The main objective of this thesis is to examine the impact of some factors
as profitability, firm growth opportunities, firm size, tangibility assets, non debt
tax shield and liquidity on leverage in context of Vietnam seafood processing and
exporting enterprises. It is to consider whether these factors are significant, if yes,
it is positive or negative related to leverage and which theory help to explain
leverage of the firms better: pecking order or trade off theory. The specific
objectives are as follows:
- To examine the significant impact of factors on leverage
- To give some policy recommendations to the firms to find a better way of
financing debt for Vietnam seafood processing and exporting enterprises.
1.3 Research questions:

The study focuses on answering the questions:
- What factors affect leverage of Vietnam seafood processmg and exporting
enterprises?
- What policy recommendations for Vietnam seafood processing and exporting
enterprises to raise effect of using leverage?
Basing on the list of factors affecting on leverage from the prior literatures,
this study will do the examination on some selected factors in case of Vietnam
seafood processing and exporting enterprises.
1.4 Research Methodology:

This paper uses annual panel data of 35 seafood processing and exporting
enterprise in Vietnam for the period 2009-2011 include both listed and unlisted
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firms .
To estimate the impact of independent variables as profitability, non-debt tax

shield, firm size, firm growth opportunities, tangibility assets and liquidity on
leverage of the firms, two methods will be used: Ordinary Least Square and Fixed

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effects (FE) or Random effects (RE) which is decided by Hausman specification
test (Dougherty (20 11) ).
1.5 Structure of the thesis:

This thesis is organized in six chapters as follows:
Chapter 1: explains the reason for choosing the thesis, its objectives and
research questions and briefly about methodology which is used to test for
hypotheses.
Chapter II: demonstrates the literature review. It starts with the concept of
leverage and capital structure. Following is some theories and prediction of
theories about determinants of leverage. Empirical studies are also presented in
this part.
Chapter III: descriptions data and variables which be used in the model. This
chapter also presents about different estimation techniques together with
hypothesis testes.
Chapter IV: presents turnover of seafood firms through some years, its export
market as well as major seafood product. This chapter also analyzes capital
structure of these firms.
Chapter V: indicates empirical results corresponding to each estimation
technique as well as results of hypothesis testes.
Chapter VI: gives conclusion of empirical results, suggest recommendations
and limitation of the thesis.

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CHAPTER II: LITERATURE REVIEW FOR DETERMINANTS OF
LEVERAGE
This chapter firstly presents about concept of capital structure as well as
leverage and optimal capital structure. Next are some leverage theories including
Modigliani - Miller theorem, agency cost theory, pecking order theory and trade
off theory. It also includes prediction of these theories about several factors
affecting leverage. Finally, empirical studies concerning these factors will be
mentioned.
2.1 Key Concepts:

+Capital structure: refers to the way that a firm finances its assets through
mixing of long term debt, short term debt, common equity and preferred equity.
It's measured by some targets as ratio of debt per total assets (also called
leverage), ratio of equity per total assets or ratio of debt per equity.
+Leverage: this study will use ratio of debt per total assets (or leverage) to
define for capital structure to consider the proportion of debt used to finance the
assets of the company. This ratio still shows the capacity of repayment of the firms
in case firms do not work effectively with debt. A higher this ratio represents for
the more debts compared with assets the companies have, the more leveraged as
well as the riskier it is considered to be.
Depending on the objective of analysis, leverage is estimated by some
ways. First, it is the ratio of total liabilities to total assets. This is a measure of
"what is left for shareholders in case of liquidation" (Rajan and Zingales, 1995,
p8). Second, it is the ratio of debt (include both short term and long term debt) to
total assets. Many researchers have chosen ratio of debt to present for leverage as
Bevan and Danbolt (2002), Huang and Song (2002) with short term and long term
debt to be examined separately, Cuong & Canh (2012) combine both short term
and long term debt. This thesis will use the ratio of liabilities to total assets to

measure for leverage include both short term, long term debt and trade credit.

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+ Optimal capital structure: the best debt to equity ratio that a firm can
have. Modigliani and Miller ( 1963) state firms will select the mix of debt and
equity that minimizes their weighted average cost of capital. Blank (2000) claims
that the optimal capital structure refers to such a ratio of using debt and equity that
maximizing the firm' market value.

+ Bankruptcy cost: is understood as the increased costs when the firms
finance with debt instead of equity that result from a higher probability of
bankruptcy. Bankruptcy cost occurs when the fixed obligations to creditor can not
be met (Robert and Lemma (1978)).

+ Agency cost: a cost of the agency relation ship which is "a contract under
which one or more persons (the principal(s) engage another person (the agent) to
perform some service on their behalf which involves delegating some decision
making authority to the agent" (Jensen and Meckling (1986)).
In short, "leverage" is the main concept in the thesis. It's used as dependent
variable and the thesis will find factors affecting it. Bankruptcy cost and agency
cost are used in explaining about effect of factors to leverage.
2.2 Related theories:

2.2.1 The Modigliani-Miller theorem:
Whenever mentioning about leverage, almost studies base on theory of

Modigliani and Miller proposition. This is considered the pioneer and the most
important theory about leverage in modem sense. It's usually still called MM

theory.
As Murray and Vidhan (2007, p.6) stated: "the Modigliani-Miller theorem
does not provide a realistic description of how firms finance their operations, it
provides a means of finding reasons why financing may matter". This theorem is
also the pattern for many later theories about leverage of the firm.
Modigliani and Miller (1958) consider linking between cost of capital and
debt of enterprise. Every model must base on certain assumptions, Modigliani and
Miller theory was not also out of this rule. Under assumptions about perfect

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markets: no transaction cost, no tax, no bankruptcy cost or no unequal access to
information, the theory concludes that firm value do not base on capital structure,
leverage have no effect on firm's value. However, assumptions about perfect
markets do not exist in reality. Until 1963, there is a progress on this theory by
adding corporate income tax on cost of capital. This leads to the results that
leverage concern with firm value. Due to tax deductibility of interest payment on
debt, the higher debt ratio the firm use, the higher value the firm get. So, this
theory supports that the firm should use debt as much as possible to inherit tax
deduction. The result of this theory has become an interest for many economists
later.
Since this pioneer theory, many other theories have been suggested to
decide determinants of leverage of the firms. Three fundamental theories which be
usually used by many researchers will be presented in next following parts.
2.2.2 Agency cost theory:
Research concerning this theory was initiated by Jensen and Meckling
(1976). Jensen and Meckling (1976, p.308) defined the agency relationship as "a

contract under which one or more persons (the principal) engage another person
(the agent), to perform some service on their behalf which involves delegating
some decision making authority to the agent". According to Jensen and Meckling
(1976), there are two types of conflict, the first is between shareholders and
managers, the second is between shareholder and debt holder. Benefit of
shareholders is related to firm's profitability, so shareholders wish for
management to run the company in a way that increases shareholder value. While
benefit of management connects closely with their income, so they may wish to
grow the company in ways that maximize their personal power and wealth that
may not be in the best interests of shareholders.
Due to conflict between various group, Jensen and Meckling (1976) argue
that agency cost play an important role in financing decisions and the optimal

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capital structure will be determined by minimizing the costs arising from these
conflicts.
2.2.3 Trade-of/theory (Myers, 1984) (or Tax based theory):
Theories about leverage are divided into two groups - theory which
proposes the optimal debt-equity ratio and theory which define no well-defined
target debt-equity ratio (Patrik (2004)). Trade off theory relating to group of
theories proposing the optimal debt-equity ratio is basing on theorem of
Modigliani and Miller (1963), this proposes that corporate income tax was added
to cost of capital and postulate the existing of an optimal capital structure.
It refers to the idea that a company should choose how much debt finance

and how much equity finance to balance the costs and benefits. Another way, it
requires a trade off between tax advantages of borrowed and cost of financial
distress. Both debt and equity used policy also have its own advantage and

disadvantage. While company heavily relies on debt have to utilize largely part of
its income for paying interest payment, a debt free company can use all of its net
income to refinancing for new investment (Zehra (2008)). However, to
compensate for loss income from paying interest payment, these companies can
inherit tax shield - is understood as the differences between taxes of a company
having debt and company without having debt on its capital structure (Wrightsman
(1978))- from its interest payment.
The optimal capital structure is at which interest tax shield balance with
bankruptcy costs and agency costs. In another way, trade off theory says that
optimal capital structure will be obtained by determining to trade off between
benefits of debt with the costs.
2.2.4 The pecking-order theory (also being called as the information asymmetry
theory):
Talking about pecking order theory, almost researches mentioned about
Myers and Majluf while Harris and Raviv (1991) raised that this theory first is

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resulted from the work of Donaldson ( 1961) and then developed by Myers and
Majluf(1984).
This theory mentions about three sources of funds as retained earnings, debt
and equity. It begins with the basic assumptions that managers have more
information about value of the firm's assets than potential investors. So this theory
is still called asymmetry theory and to be considered as contestant with "trade-off
theory. Both manager and investor know about this fact. According to Myers and
Majluf (1984 ), due to lacking of information about the firm, outside investors will
tend to misprize equity of the firm. Even if NPV of the project is positive, it also
may not be accepted (Harris and Raviv, (1991)).
In order to minimize the problem of information asymmetry between

managers (insiders) and investors (outsiders) and avoid underinvestment, this
theory encourage using other ways of collecting fund instead of issuing equity.
Myers and Majluf (1984, p.46) went to the result that "firms should go to bond
market for external capital, but raise equity by retention if possible. That is,
external financing using debt is better than financing by equity". Particularly, this
theory proposes that when the firms collect capital for new investment, it should
follow a hierarchy financing. Firstly, it will choose internal funds (retained
earnings) and only when this source of fund is exhaust, it will acquire external
funds. Using external funds, firms also give priority to debt instead of equity.
Issuing equity is considered the most expensive way to collect fund for new
investment, so in order to avoid transaction costs, firms will choose this way as the
last channel of collecting fund (Fama and French (2004)) when it does not have
any other selection. The decision rule of Myers and Majluf (1984, p.3) is "take
every positive- NPV project, regardless of whether internal or external funds are
used to pay for it". This theory also argues that there is no well-defined target
leverage and leverage depends on active business and investment need. Due to
raising the role of internal funds, according to this theory, profitability of the firm
is one of the most important factors affecting leverage of the firm.

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Deciding to choose external financing to finance new investment is not only
because of existing asymmetric information problem but also relating to position
of organizational sales and structure of the firms (Mehmet and Eda (2008)). Firms
with stable sales will create belief in lenders about collecting loan due to stable
profitability, so they will easily to borrow than other firms. Similarly with firms
which have larger size and structure since they will have more collateral assets to
ensure for their loan.
Murray and Vidhan (2007, p.1) recognize that "private firms seem to use

retained earnings and bank debt heavily. Small public firms make active use of
equity financing. Large public firms primarily use retained earnings and corporate
bonds".
From the above theories, some important factors affect leverage of the
firms as profitability, growth rate, firm size, tangibility assets, liquidity and nondebt tax shield which will be explained clearly in next part.
2.3 Determinants of leverage:

Determinants of leverage can be divided into two groups as firm specific
factors which are considered as internal factors and industry or country specific
factors which are considered as external factors (Antoniou et al. (2002) and
Gurcharan (20 10) ). External factors including macro elements are out of control of
the firms. Due to limitation of data, this study only bases on investigating about
firm characteristics that can be controlled by the manager of the firm. Moreover, it
seems that firm specific factors affect leverage more strongly than industry
specific factors (Mac (2010)). DeJong et al. (2008) considering both firm specific
factors and country specific variables also conclude that firm specific factors have
dominant role to determinants of leverage.
There are many factors having means to leverage, however as Harris and
Raviv (1991, p.299) claims in their research: "the models surveyed have identified
a large number of potential determinants of capital structure. The empirical work

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so far has not, however, sorted out which of these are important in various
contexts".
Harris and Raviv (1991, p.334) has summarized results from many studies
that "leverage increases with fixed assets, non-debt tax shields, growth

opportunities, and firm size and decreases with volatility, advertising expenditures,
research and development expenditures, bankruptcy probability, profitability and
uniqueness of the product". Due to lacking of data, this study will base on some of
factors which are found significant in research of Harris and Raviv ( 1991) such as
profitability, firm size, growth rate, non-debt tax shield and tangibility assets plus
of liquidity ratio as Zehra (2008) uses to check for Vietnam seafood processing
and exporting enterprises. Three factors which the study investigates as
profitability, tangibility and firm size are also three of six core factors that make
changing up to 27% of the leverage in many studies before. (Murray and Vidhan
(2007)).
Pecking order theory and trade off theory are considered as two mam
theories in explaining determinants of leverage of the firms in almost previous
studies. Both of these theories can explain leverage although explanation of each
theory about effect of factors is different. Some researches support that pecking
order theory explain better choice of leverage (DeJong et at (2008), some others
incline to follow trade off theory (Murray and Vidhan (2007) or Jason and Eric
(2009)) whereas there are also researches argue leverage is consistent with
prediction of both pecking order and trade off theory (Deesomsak et al. (2004 ),
Antoniou et al. (2002). In context of Vietnam firms, Dzung et al. (2012) states that
pecking order theory explains better leverage of firms.
This study also focuses on both pecking order theory and trade off theory to
find whether leverage of Vietnam's firm is affected by which theory. The
following section will explain impact of each factor on leverage according to point
of view of pecking order theory and trade off theory one by one. Pecking order
theory seems to be better than trade off theory in explaining leverage of the firms
due to according trade off theory, firms should take more debt to inherit tax shield

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deduction, however, in reality, there are some firms with high profit take less debt.
This theory can not explain for that. With pecking order theory, this is explained
through firms' hierarchy of finance: retained earnings, debt and equity.
2.3.1 Leverage and Profitability:
Theoretical prediction about effect of this factor on leverage is inconsistent.
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According to trade-off theory, profitability of a firm clearly has positive
relationship with leverage and it's also a key point of this theory (Fama and
French (2002), Mehdi et al. (2011)). Profitable firms seldom meet problem with
financial distress and they also find interest tax shield more valuable (Murray and
Vidhan (2007)). Therefore, higher profitability encourage firm to take more debt
to finance investment in order to inherit tax benefit of debt. Moreover, a firm with
high profitability may create belief in lender, so it's easy for them to borrow than
firms with bad profitability (Philippe et al. (2003)).
On the contrary, the pecking order theory supports a negative relationship
between them. Because of asymmetric information situation, cost of collecting
outside capital will be always higher than inside capital. So manager likely to use
retained earning for self supporting if any. Especially, firms with higher
profitability will certainly have more retained earnings. Therefore, the firm will
use this internal source of fund to finance its investment, without depending on
external finance to avoid problem of changing of interest rate or pressure of
repayment at due date, so level of ratio of debt will be at low degree.
Most empirical studies are in line with pecking order theory that
profitability have negatively correlated with leverage. Murray and Vidhan (2007,

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p.32) supports that "firms that have more profits tend to have less leverage".
Akinlo (2011) uses data of 66 Nigerian listed firms over the period 1999-2007
argues that good profitability firms tend to reduce their need for external debt. LiJu and Shun-Yu (2010) find the most significant variable impact on leverage is
profitability and its coefficient is negative. This result found base on data of 305
Taiwan electronic companies, one of most important industry in Taiwan, during

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the year 2009. Titman & Wessels ( 1988), Schoubben and Van Hulle (2004) also
have the same results. While supporting for trade off theory, Mehdi et al. (2011)
find that profitability is the most influential factor on leverage and it has positive
impact on leverage.
In context of Vietnam, enterprises feel difficult to borrow from bank due to
high transaction cost plus of so many requests as tangibility assets, aim of using
fund or checking after supplying loan ... so enterprises with more retained earning
likely to use this source for financing and avoid taking debt from bank. It seems
that pecking order theory is more suitable to explain for leverage of Vietnam
firms. So, a first hypothesis is conducted for the relationship between profitability
and leverage as follows:

Hl: There will be negative relationship between profitability and leverage
2.3.2 Leverage and Firm size:
One of main conditions to be considered whenever lenders approve of

financing for a firm is related to its size. From the point of view of pecking order
and trade offtheory, the effect of firm size on leverage is mix.
Pecking order theory predicts a negative relationship between size and
leverage of a company. Large firms seldom meet problem with information
asymmetries, so the costs of issuing equity for large firms are lower than small

firms. Moreover, due to information about large firms is more popular with
outside investors, they will likely to get equity of these firms (Huang and Song
(2002)). With low cost of issuing and preference of outside investors, certainly
large firms will give priority to issuing equity to finance for new investment
project to economize the cost instead of taking debt.
With trade off theory, the relationship is positive. Due to the larger the
firms are, the more diversified they are, so size is still considered as an inverse
proxy of probability of bankruptcy (Titman and Wessels, (1988)). Large firms will
less be impacted by bankruptcy, hence they are easily to borrow with lower
interest rate (Pinches and Mingo, (1973)), so the leverage will be higher. Besides,

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lenders also prefer to supply debt to larger firm than smaller firm due to it's easier
for them to get repaid (Joshua, (2008)).
Empirical studies support for the trade off theory and find the positive
relationship as Patrik (2004) with data of Czech. Murray and Vidhan (2007) with
data of publicly traded American firms conclude that "larger firms tend to have
high leverage" (p.32). Research of Amarjit (2011) about 166 Canadian listed firms
for the period of 3 years from 2008 to 2010 also find that leverage positive related
to firm size. Rajan and Zingales (1995) find positive relationship for almost
countries in G-7 except for Germany. Pervez (2009) supports that large firm tend
to borrow more debt than smaller do. With data of Vietnam, Anh (20 10) also find
the positive relationship between firm size and leverage. In a research about
demand of debt of six African countries, Bigsten et al. (2000, p. 7) supports that
"small and medium sized firms are less likely to get a loan". In this research, the
writer argues that smaller firms usually meet problem with credit. So, although
these firms have high demand of debt, their request usually are rejected than larger
firms. While ratio of demand but rejected of micro firms is 64%, small firms is

42% and medium firms is 21%, this ratio is only 10% for large firms.
In opposite with those results, Abel (2008) follows pecking order theory
and do not agree with positive relationship between firm size and leverage in case
size is explained as a inverse proxy for bankruptcy cost. The result of the research
about 71 quoted firms in Nigerian stock market during the period 17 years from
1990 to 2006 supports for a negative related due to "larger firms that have built
enough reserves may choose to finance their operations through their respective
internal markets, rather than passing through the difficulties inherent in accessing
the external financial markets" (p.9).
In context of Vietnam, larges firms usually receive favors of many banks.
These banks competes each other to attract them through reducing interest rate and
cost.
So, a second hypothesis is conducted for the relationship between firm size
and leverage as follows:

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H2: There will be positive relationship between firm size and leverage

2.3.3 Leverage and Firm Growth:
The relationship between growth and leverage of the firm is still unclear
with different theories. While the pecking order theory argues a positive
relationship, trade off theory states a negative one.
With trade off theory, growing of the firms is only intangible assets, so it
can't be used as collateral to borrow. Moreover, firms with more investment
chances tend to have lower leverage since they have stronger incentives to avoid
under-investment and asset substitution that can arise from stockholderbondholder agency conflicts (Drobetz and Fix (2003))
Researches of Raj an and Zingales ( 1995) plus of Titman and Wessels
(1988) supports for this negative relationship. Huang and Song (2002) also find

that in China, firms with high growth rate in the past tend to have higher leverage
while firms with good growth opportunity at present have lower leverage. Patrik
(2004) states that firms with higher growth opportunities tend to give priority to
using equity. Gurcharan (2010) agrees that firm with high growth have many other
developing chances, so they do not need to take much debt to avoid the restriction
of lenders. Akinlo (20 11) also supposes that growing firms do not depend too
much on debt financing for Nigerian case.
From the perspective of pecking order theory, the requirement of finance of
the firms will increase together with its growing. The internal fund cannot fill their
need. And if only depending on this source of fund, the growth of firms may be

..

restricted. So the firms tend to take more second source of finance - debt - to
finance for their investment. Researches encourage for this theory as Baskin
(1989), Bevan and Danbolt (2002). Most of researches for Vietnam context
indicate that firms with high growth will finance with more debt (Nguyen and
Ramachandran (2006) and Biger et al (2008)). Therefore, a third hypothesis is
conducted for the relationship between firm growth rate and leverage as follows:

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H3: There will be positive relationship between growth rate and
leverage
2.3.4 Leverage and Non-debt tax shield:
Non-debt tax shield is a characteristic that fits in with only the trade off

theory. According to this theory, firms should take more debt to inherit deducting

..

corporate tax. However, besides this way, firms also can reduce corporate tax by
using non-debt tax shield as depreciation. Therefore, this theory supports for a
negatively correlated between non-debt tax shield and leverage. The more
depreciation the firms have, the less potential debt they will use. De Angelo and
Masulis ( 1980), one of the persons who care and raise the role of non-debt tax
shield argue that non-debt tax shields are substitutes for a debt-related tax shield,
so firms with large non-debt tax shield can also inherit tax deduction and have less
demand of debt on their capital structure. However, Scott (1977) proposes a
contradiction. Scott ( 1977) connects debt capacity of the firm with non debt tax
shield to explain for positive relationship between leverage and non-debt tax
shield. According to his opinion, firm with more collateral assets also have more
depreciation. Besides getting tax deduction from depreciation, these firms will
make use of having lower interest rate from secured debt to borrow more. So,
together with increasing of non-debt tax shield, leverage of these firms also
increase.
In reality, most of empirical studies support for negative relationship of
trade off theory and De Angelo and Masulis (1980) although there are also some
exceptions depending on country characteristics. Linda and George (200 1) with
Dutch data, Patrik (2004) with Czech data support for this negative relationship
that non-debt tax shield as substitutes to debt-related tax shield whereas Bradley et
al. (1984) reports a positive relationship. Gurcharan (20 10) with study about some
selected countries in Asean region claims that due to being inherited benefit from
non-debt tax shield, firms likely to reduce using debt. Liaqat (20 11) used data of
170 Indian companies in the textile industry for the period 2005-2010 find a

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