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PII: S0275-5319(16)30343-9
DOI: http://dx.doi.org/doi:10.1016/j.ribaf.2017.07.012
Reference: RIBAF 702
Please cite this article as: Le, Thi Phuong Vy, Phan Thi Bich, Nguyet, Capital Structure
and Firm performance: Empirical evidence from a developing country.Research in
International Business and Finance http://dx.doi.org/10.1016/j.ribaf.2017.07.012
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Capital Structure and Firm performance: Empirical evidence from
a developing country
Graphical abstract
VIETNAM – A SMALL TRANSITION COUNTRY
Capital structure
(Book leverage, market leverage) Firm performance
(ROA, ROE, Tobin Q)
Firm characteristics: growth, investment,
liquidity, risk, dividend and cash flow
Abstract
The research uses unbalanced panel data from all non-financial listed firms during the period
2007–2012 to investigate the effect of capital structure on firm performance in Vietnam. The
results indicate that all debt ratios have significantly negative relation to firm performance. This
outcome is not in accordance with most studies conducted in developed countries, which posit a
positive relationship between capital structure and firm performance; however, it is consistent
with some studies in the context of developing markets. This paper argues that in typical
developing market like Vietnam, the benefits of debt from tax saving may be less than financial
distress cost. In addition, the monitoring role of debt is not substantial because of severe
information asymmetry and under-developed financial system. Our research results are robusted
by using different approaches.
1. Introduction
Capital structure and its effect on firm performance is a core issue in finance and there are a
number of theories explaining this relationship. Modigliani–Miller (MM) theory (Modigliani &
Miller 1958), considered as the foundation theory, posits that the firm value is not influenced by
its capital structure. However, this theory is based on restrictive assumptions of a perfect capital
market that does not exist in the real world. To account for an imperfect market, the three main
theories that have been suggested as alternatives to MM theory are trade-off theory, pecking
order theory and agency theory. Trade-off theory (Kraus & Litzenberger 1973; Myers 1984)
claims that a firm will trade off costs and benefits of debt to maximize firm value. The benefit of
debt primarily comes from the tax shield of decreasing income through paying interest (Miller &
Modigliani 1963). The cost of debt is derived from direct and indirect bankruptcy costs through
the increase in financial risk (Kim 1978; Kraus & Litzenberger 1973). The pecking order theory
(Myers & Majluf 1984; Ross 1977) states that financing follows hierarchy: internal financing is
used first, then debt is issued, and equity is issued when no more debt can be approached.
Agency theory, developed by Jensen and Meckling (1976), Jensen (1986) and Hart and Moore
(1994), contends that an optimal capital structure to maximize firm value must be the one which
minimizes conflicts of interest among stakeholders.
However, an important noticeable point is that there is no single theory that can fully interpret
the effect of capital structure on firm performance. Adralan (2017) argues that all these theories
are based on many critical assumptions, while the real society is extremely complex and
diversified. He states that theorists are not always totally aware of the multifaceted natures of
society or tradition. Furthermore, most finance researchers are limited on the functionalist
paradigm, meanwhile each paradigm such as functionalist, interpretive, radical humanist or
radical structuralist leads to distinctive research approach, thus generates distinguished
understandings (Burrell and Morgan, 1979; Lagoarde-Segot, 2016). His study thus concludes
that the results of any model and the predictions of any theory might change when the underlying
assumptions are modified. In particular, the impact of capital structure on firm value could vary
significantly in different contexts or the statements of the traditional capital structure theories
could become questionable under different conditions. Lagoarde-Segot (2016) also indicates that
modern finance could be diversified by using different paradigm, new metaphors, and rigour in
puzzle-solving.
Before 1986, the time Vietnam started its Doi moi – a comprehensive economic renovation
program, capital structure was not an issue because most of enterprises are state-owned, so they
got funded by the government. With the recognition of existence of private sectors after the Doi
moi program, as well as the opening to the stock market in 2000 capital structure becomes a
concerning issues of the managers. Nevertheless, Vietnam is still an emerging market which
lacks of sufficient financial instruments as well as supporting policies and guidance for firms to
seek a suitable capital structure (World bank, 2011). Whether or not capital structure effects on
firm performance in a context of a small transition economy like Vietnam remains unanswered.
The above issues motivate new studies on the relationship between capital structure and firm
performance, specifically in Vietnam.
Although many studies have been conducted in other countries, there are few in-depth research
in Vietnam. In addition, empirical evidences recently show different and contradictory results
and indicates that this relationship depends significantly on the specific circumstances. Therefore
this study contributes to the theoretical perspective by providing an insight into the relationship
between capital structure and firm performance in an typical transition market. In addition, it
provides evidence for testing the validity of financial theories in explaining the relationship
between capital structure and firm performance in an transition and developing country like
Vietnam.
This paper is organized as follows. Section 2 provides an overview of research context. Section 3
gives a literature review; section 4 details the methodology and the empirical models; section 5
shows the results with a discussion; and section 6 is the conclusion.
Moreover, to increase the efficiency of the model, testing for groupwise heteroskedasticity
through the Wald test and autocorrelation by the Wooldridge test were conducted. If
heteroskedasticity and autocorrelation exist in the model, robust standard errors will be
calculated to enhance the efficiency of estimators.
Although a model-adjusted standard error can deal with heteroskedasticity problems and
autocorrelation, Wintoki, Linck and Netter (2012) have claimed that bias relating endogeneity
still exists. This is because the FE and RE models mainly control for unobserved heterogeneity.
They do not account for the endogeneity problem, which is caused by the measurement errors,
time-invariant endogenous variables and reverse causality that often take place in the field of
finance research. Therefore, using FE or RE models could still be biased, especially in short
panel data (Cameron & Trivedi 2005). To deal with this issue, some previous studies have
suggested using instrument variable estimators (IV estimators) or dynamic panel GMM.
However, the problem when applying IV estimators is the difficulty in finding variables that can
serve as valid instruments because with weak instruments, the IV estimators are likely to be
biased. In other words, IV estimates with invalid instruments could offer no improvement over
OLS estimators. Therefore, this research applied the dynamic panel GMM explored by Arellano
and Bond (1991) to deal with the endogeneity issue.
One of the advantages of the GMM model over the instrument estimator method is that it is
much easier to have instrument variables as exogenous variables in other time periods or lag of
variables can be used as instruments for endogenous variables in the current time period.
Therefore, GMM provides an abundance of instrument variables, which makes it easier to
achieve the conditions of valid instruments and overidentification of estimators. In addition, the
Arellano and Bond estimator is suitable for short panel data that have small T and large N,
meaning few time periods and many individuals. In a large T panel, the specific characteristics of
firms that appear in the error term will decrease with time and the correlation of lagged variables
with the error term is insignificant (Roodman 2006). In this case, other methods can be better
than the Arellano and Bond estimator. This research used short panel data with large companies
and only six years, so the GMM method introduced by Arellano and Bond (1991) was employed
and believed to be appropriate.
An issue of the original Arellano and Bond (1991) estimator, which is called difference GMM, is
that lagged variables can be weak instruments if the variables in regressions are close to a
random walk, because lagged levels transfer little information about changes in the future. In
addition, the difference GMM has a weakness when there are many gaps in unbalanced panels
(Roodman 2006). Therefore, Arellano and Bover (1995) and Blundell and Bond (2000)
developed the system GMM, in which the original equation is added to the system to increase
instruments, thereby increasing the efficiency of the estimators. In this estimator, lagged
differences are employed as instrument variables for equations in levels and lagged levels are
used as instruments for equations in first differences.
Arellano and Bond (1991) suggested two key tests to check for the validity of the GMM model.
The first test is the Sargan test or Hansen test of overidentification. GMM requires that the
overidentifying restrictions be valid. The second test is the Arellano-Bond test for
autocorrelation errors. The residuals in first differences AR (1) are expected to correlate, but
there should be no serial correlation in second differences AR (2). The condition for the second-
order serial correlation test is that any historical value of dependent variables beyond the certain
lags, which control for the dynamic aspects of an empirical relationship, is a valid instrument
because it will be exogenous to the current shocks of dependent variables (Wintoki, Linck &
Netter 2012).
Although GMM estimators are now becoming increasingly popular, one disadvantage of the
difference and system GMM is that they are quite complicated and so easily create invalid
estimates (Roodman 2006). Therefore, this research reported all results of OLS, RE, FE and
GMM to compare and ensure the reliability of the findings.
Finally, for checking the robustness of the results, this research ran regressions in which industry
and year dummy variables were included to capture industry- or year-specific FE. In addition,
alternative measurements of dependent or independent variables were applied to retest the
results.
4.4 Empirical model
To test the relationship between capital structure and firm performance, this research used the
following model:
, = + , + , + , (1)
where FPi,t is firm performance of firm i at time t and measured by Tobin Q, ROA and ROE;
CSi,t is a capital structure of firm i at time t and measured by the ratios of long-term debt, short-
term debt and total debts to book value and market value of total assets; Zi,t is a vector of control
variables.
According to hypothesis 1 (H1), leverage would have a negative effect on firm performance,
hence, a negative sign on in model 1 was expected.
To capture the industry- and year-specific FE, this research employed the following models:
, = + , + , + . + ,
, = + , + , + . + ,
In addition, testing the linear relationship between capital structure and firm performance, this
research used the quadratic function underpinned by the studies of Berger and Bonaccorsi di
Patti (2006) and Margaritis and Psillaki (2010) to allow a non-linear relation.
, = + , + , + , + , (2)
Hypothesis 2 (H2) proposed that there would be an inverse U-shaped relationship between
capital structure and firm value. In particular, leverage is associated positively with firm value;
however, at a high leverage, the relationship switches from positive to negative. This quadratic
function allows that the relationship between capital structure and firm performance may not be
monotonic, that is, it may switch from positive to negative at higher debt ratio. The adequate
condition for the inverse U-shaped relationship between capital structure and firm value is that
> 0 and < 0.
Control variables in the models
Based on studies of King and Santor (2008), Tian and Zeitun (2007), Margaritis and Psillaki
(2010), some other main factors affecting firm performance are detailed as follows:
Growth
Most previous studies posit that growth is positively correlated to firm performance because
firms with a high growth rate are able to create more profit and value from investment
opportunities. King and Santor (2008) found a positive association between growth rate
measured by sales growth and firm performance measured by Tobin’s Q. Tian and Zeitun
(2007), Gleason, Mathur and Mathur (2000) and Jiraporn and Liu (2008) found that a firm’s
growth opportunity has a positive and significant effect on firm performance measured by ROA.
Margaritis and Psillaki (2010) found a positive relationship between sale growth and firm
efficiency.
Investment
Prior studies agree that firm performance is related to investment opportunities. Cho (1998)
argued that firms with many investment opportunities may have high firm performance as a
result of their investing. Hoshi, Kashyap and Scharfstein (1991), studying in Japanese firms, and
Kaplan and Zingales (1995) conducting research in the United States, provided evidence that the
effect of investment on Tobin’s Q is significant and positive.
Liquidity
Cho (1998) argued that liquidity was one of the signals of firm performance and prospects. Firms
with high liquidity are expected to have good performances and more investment opportunities.
In addition, firms with a high level of cash can support their new projects, pay dividends or
mitigate financial distress problems. Therefore, liquidity is predicted to relate positively to firm
performance.
Profitability
Most prior studies have indicated a positive effect of profitability on firm performance. They
have argued that firms with high profitability are generally better performers and more efficient,
and thus are expected to have high firm performance (Margaritis & Psillaki 2010).
Risk
Tian and Zeitun (2007) pointed out that there is a significant negative relationship between risk
and firm value because a higher risk implies higher financial distress cost, thereby reducing firm
performance. Bloom and Milkovich (1998) observed that high risk level may be related to poor
firm performance because the greater variability in a firm’s outcomes increases the probability of
corporate ruin. In addition, they indicated that high business risk makes firms more difficult to
formulate a strategy or future actions, thus negatively affecting firm performance.
Cash flow
Jensen (1986) stated that with high cash flow, firms may invest in inefficient projects; hence, it
will harm the firm’s performance. In a study by Chung, Firth and Kim (2005), cash flow raised
the agency problems between the insiders and outsiders. Managers of firms with large cash flow
have opportunities to increase the scope of their authority. As a result, it leads to
underinvestment and reduces the wealth of shareholders. However, Gregory (2005) and Chang,
Chen and Huang (2007) documented a positive association between cash flow and firm
performance. These authors explained that high cash flow enables firms to undertake positive
investment without raising external funds at high cost.
Dividend
In a perfectly competitive market, dividend policy is irrelevant to firm performance (Miller &
Modigliani 1963). However, in an imperfect market, dividend policy is seen a relevant to firm
performance. Dhanani (2005) provided evidence on the positive relationship between dividends
and firm performance. The author argued that dividends can resolve agency problems or
information asymmetry between managers and shareholders, thereby enhancing the firm
performance. Amidu (2007) argued that dividends are the best and most reliable signal of firm
prospects. A high dividend payout signals that the firm is confident of its strong earnings in the
future.
5. Findings
5.1 Descriptive statistics of data
Summary statistics of all variables as proxies of capital structure, firm performance, ownership
structure and control variables are shown in Table 3. The average of total book leverage (TLEV)
and total market leverage (MTLEV) overall account for 51.92% and 53.52% during the period
from 2007 to 2012 and widely disperses, from 0.26% to 97.79% and from 0.26% to 98.12%,
respectively. These ratios reveal that Vietnamese firms overleveraged compared with those in
other countries. Specifically, they are higher than firms in developed countries: 22% observed by
De La Bruslerie and Latrous (2012) for French companies during the period 1998–2009; 33.4%
reported by Lin et al. (2011) for 22 Western European and East Asian countries from 1996 to
2008; and only relatively the same 47% reported by Zou and Xiao (2006) for China listed firms.
This is possibly due to, as mentioned in the context analysis, the domination of the banking
sector and the early stage of development of the country’s stock market and financial market. In
other words, Vietnamese listed firms are mainly financed by the banking sector rather than the
stock market or other sources. In addition, the mean ratio of short-term debt (short-term leverage
[SLEV]) is 41.09% and much higher than long-term debt ratio (long-term leverage [LLEV]),
which is only 10.83 %. Similarity, while market long-term debt [MLLEV] is only 11.02%,
market short-term debt [MSLEV] accounts up to 42.59% in total capital structure. This indicates
that Vietnamese listed firms are heavily dependent on short-term debt rather than long-term one,
which could lead to a substantial effect on firm’s performance as short-term debt drives firms to
the risks of refinancing and liquidity. It also needs to be noted that all debt ratios based on
market value (MTLEV, MLLEV and MSLEV) are slightly higher than those measured by the
book value (TLEV, LLEV and SLEV). This could be a result of the depreciation of the
Vietnamese stock market during this period.
Firm performance indicators are presented by ROA, ROE and Tobin Q. The average of returns
on equity and assets for the full sample as a whole are 6.3% and 10.3%, respectively. The
average values of Tobin Q represented market performance is 1.15, which is lower than that
observed for Singapore firms (2.03), Malaysian firms (1.77) (Mak & Kusnadi 2005) and Chinese
firms (1.41) (Ruan, Tian & Ma 2011). Figures also show that the value of Tobin’s Q of listed
firms varies from 0.26 to 20.93. The two alternative measures of firm performance, ROA and
ROE, suggest a large spread in their value. The ROA of listed firms ranges from –0.83 to 0.59,
and the ROE of those firms ranges from –15.28 to 0.95. This implies that there was a significant
gap in firm performance among Vietnamese listed firms during this period.
[ Table 3]
5.2. Correlation analysis
The correlation coefficients between variables used in the regression models are presented in
Table 4. It can be observed that the correlation of debt ratios used as proxies of capital structure
are high. In particular, the correlation coefficient between market total debt ratio (MTLEV) and
book total debt ratio (TLEV) is 0.82. Therefore, instead of combining both debt ratios in only
one regression, this research separately examined the effect of each type of debt ratio on firm
performance to minimise the multicollinearity problem. Other correlation coefficients are quite
small (below 0.5), implying that other variables are suitable in the regression models.
Debt ratios, including market total debt ratio (MTLEV) and book total debt ratio (TLEV), were
found to be negatively related to ROA, ROE and Tobin Q because all coefficients of pairwise
correlation among these variables are negative and significant at the 5% level. Specifically, the
correlation coefficients presenting the link of TLEV with ROA, ROE and Tobin Q are –0.4305, –
0.1294 and –0.1679, while the figures of MTLEV are –0.5730, –0.1805 and –0.4398,
respectively.
[ Table 4 ]
5.3 Pooled OLS regression
First, the OLS regression (pooled OLS) was performed. Table 5 presents the pooled OLS results
for firm performance equation using ROA, ROE and Tobin’s Q as dependent variables,
respectively. While ROA and ROE were used to capture accounting performance, Tobin Q was
employed to capture market performance.
[ Table 5 ]
As shown in Table 5, capital structure is negatively associated with firm performance because
the coefficients estimators for the debt ratios are significantly negative at the 1% level.
Specifically, the coefficient of book total debt ratio and market total debt ratio in columns 1 and
2 are –0.105 and –0.132, which denotes that an increase of 1% in total debt ratio will lead to a
decrease of approximately 0.1% in ROA, holding all other variables constant. However, the
coefficients of debt ratios in columns 3 and 4 are around –0.2, suggesting that when total
leverage rises 1%, the ROE will fall about 0.2%, all else held equal. Remarkably, the coefficient
of market total debt ratio in Tobin Q regression is –1.101, which is much higher than other debt
ratio coefficients in other regressions (from –0.1 to –0.2), implying that the effect of debt ratios
on Tobin Q is much stronger than on ROA and ROE.
Another significant point is that overall F-tests with all p-values below 1% report good fitness of
the models. In addition, most adjusted R-squared values are moderate, from 0.1327 to 0.6484.
Especially in ROA regressions, the values of adjusted R-squared are around 0.60, reflecting that
the models can explain 60% the change of ROA. However, as discussed in the methodology
chapter, regression using the OLS method cannot control for unobserved individual effects,
which commonly appear in most research using cross-sectional data. Therefore, FE and RE
modelling were conducted alongside pooled OLS for unobserved individual effects.
5.4 Random and fixed effect regression
Table 6 shows the outcomes of FE and RE models. Both models’ results provide that the
coefficients of leverage ratio are negative but differ slightly in the significance levels. To select
the appropriate model between FE and RE, the Hausman test was performed. The results of chi-
square statistics are all significant at the 1% level, favouring the FE model over the RE model.
The Wald test also shows that the FE model is better than pooled OLS. Hence, the FE estimator
was used to investigate the effect of leverage on firm performance.
The results of the empirical model using the FE method in Table 5.17 confirm that the
relationship between capital structure and firm performance is negative. Columns 1 to 4 report
the results of examining the relationship between capital structures on ROA, columns 5 to 8
present the results of regression using ROE as a dependent variable and columns 9 to 12 report
the results of Tobin Q regression. In general, it reveals a negative relationship between capital
structure and firm performance because most estimated coefficients of debt ratios measured by
total book debts and total market debts are negative and statistically significant at the 1% level
except the coefficient of book leverage in Tobin Q regression. On average, a 1% increase in total
book debt will decrease 0.134% in ROA, 0.393% in ROE and 0.303 units in Tobin Q. Similarly,
when market total debt increases 1%, ROA, ROE and Tobin Q will decline 0.137%, 0.281% and
2.06 units respectively, holding all other variables constant.
Besides unobserved individual factors, other potential concerns are heteroskedasticity and the
autocorrelation phenomenon, which can lead to inefficiency of the model coefficients. Therefore,
the Wald test for heteroskedasticity and the Wooldridge test for autocorrelation were conducted.
[ Table 6 ]
The results of the Wooldridge test for autocorrelation are not deemed reliable when the time
period is short. In this study, the data spans six years; therefore, it is widely accepted that the
autocorrelation issue could be neglected in the short panel data. However, this research still
conducted the Wooldridge test for autocorrelation as a reference. The results of the Wald test (all
Prob > Chi2 = 0.000) report that the heteroskedasticity problem exists in the models. Similarly,
the Wooldridge test revealed a presence of autocorrelation in all regressions. To control these
issues, the study then adopted the FE model with adjusted standard errors.
Table 7 reports the outcomes on the relationship between capital structure and firm performance,
which were estimated by the FE estimator with adjusted standard error. Overall, all results
remain similar with the FE model reconfirming the negative relationship between leverage and
firm performance in Vietnamese listed firms. Specifically, most coefficients of capital structure
variables are negative and statistically significant at the 1% level except the coefficient of book
debt ratio in Tobin Q regression, which is still negative but insignificant. This means that an
increase in the total debt ratios, ceteris paribus, is associated with a decrease in firm
performance. Results also demonstrate that the effect of leverage ratio on Tobin Q is stronger
than that of leverage ratio on ROA and ROE because the coefficients of book debt and market
debt ratios in Tobin Q regression are much higher than those in ROA and ROE regression. A
worthy point is that the R-squared values in all regressions are quite good, from 0.1460 to
0.7147. In particular, these figures in the ROA model are considerably high (around 0.70),
implying that the model could explain up to 70% of the change of ROA in Vietnamese listed
firms. In addition, the F-test results show that the fitness of models is fairly good.
[ Table 7 ]
Using the FE model with robust standard error can help to control unobserved effects as well as
heteroskedasticity; however, the endogenous issue, which leads to biased and inconsistent
estimators, may still exist. This is caused by the inability to ascertain if a simultaneous reverse
relation link exists between capital structure and firm performance (i.e. firm performance also
affects capital structure decisions). In addition, capital structure can be considered simply an
indicator of unobserved features that influence performance. To strengthen the research
outcomes, system two-step GMM with adjusted standard error was applied to cope with the
endogenous problem.
The outcomes of the system GMM are reported in Table 8. It once again confirms the negative
relationship between capital structure and firm performance. This negative relation is mostly
statistically significant at the 5% and 1% levels in most models, except the coefficient of total
debt ratios in the Tobin Q equation and the coefficients of market total debt ratios in the ROE
equation. These are negative but insignificant. The results also reveal that the signs of most
control variables, including growth rate, risk business, cash flow and dividend yield, are
consistent with OLS, RE and FE methods, but slightly different in significance level.
The results of the specification tests of the models are reported in Table 5.19. While AR(1) and
AR(2) test the first- and second-order serial correlation, the Hansen J tests the overidentifying
restrictions. All p-values of AR(2) tests in the table are higher than 0.10, which means that the
null hypothesis of no second-order serial correlation cannot be rejected. Similarly, the results of
the Hansen J tests reveal that the null hypothesis that instrument variables are valid or cannot be
rejected.
[ Table 8 ]
5.6 Results
Capital structure
A negative relationship between capital structure and firm performance is supported by all
models. The consistency of the debt ratios sign under the different methods applied illustrates the
robustness of the findings. Remarkably, the effect magnitude of market total debt ratio is
considerably higher than those of book total market. These results are not consistent with the
studies of Berger and Bonaccorsi di Patti (2006), Gill, Biger and Mathur (2011) and Margaritis
and Psillaki (2010), but are in line with work by Majumdar and Chhibber (1999), Tian and
Zeitun (2007) and Joshua (2007). This could be explained by Harris and Raviv (1991), who
suggested that underestimating bankruptcy costs of liquidation or reorganisation may lead firms
to have more debt than the appropriate level; therefore, a high debt ratio would decrease firm
performance. In addition, large cash flow from debt can lead managers to undertake
discretionary behaviour or negatively affect firm performance. Furthermore, Stulz (1990) argued
that interest payments from issuing debt may exhaust firm cash flow and reduce available funds
for profitable investment, which negatively affects firm performance. Further discussion in the
next chapter sheds more light on this argument.
Control variables
In reference to control variables, whereas growth rate, cash flow, investment, liquidity, and risk
have significant coefficients in most regressions, the others have not consistent effects on firm
performance.
The estimated coefficients of growth rate and investment are positive and statistically significant,
indicating that firms with higher growth opportunities can enhance their performance measured
by ROA, ROE and Tobin Q. The result is consistent with the studies of Tian and Zeitun (2007),
Gleason, Mathur and Mathur (2000), Jiraporn and Liu (2008) and Margaritis and Psillaki (2010),
which argued that firms with high growth rate are able to create more profit and value from
investment opportunities.
The coefficient estimates of cash flow are positive and statistically significant at the 1% level in
all models, suggesting that cash flow is an important factor affecting firm performance. This
result is in line with the studies of Gregory (2005), Chang, Chen and Huang (2007). These
authors explained that firms with high cash flow could undertake positive investment without
using external funds at high cost. The coefficients of the liquidity factor are positively significant
at the 1% level in the ROA equation, but insignificant in ROE and Tobin Q equations. The
explanation could lie in Cho (1998), which argued that high liquidity enables firms to have more
investments and mitigates financial distress problems, thereby increasing firm performance.
Conversely, the risk of business is negatively related to firm performance as its coefficients are
significantly negative at 1% level in OLS, RE and FE regressions, but not significant in all GMM
estimators. This finding is consistent with most previous studies, for example the studies of Tian
and Zeitun (2007) and Bloom and Milkovich (1998). This could explain that higher risk leads to
higher financial distress costs or increases the probability of corporate ruin, thereby reducing
firm performance. In addition, high risk makes firm more difficult to decide a future strategy,
thus negatively affecting firm performance.
5.7 Robustness check
The results of the robustness tests conducted are consistent with the main results of this study
and generally support the conclusion that there is a negative relationship between capital
structure and firm performance. A noted point is that the tables that show the regression results
are not reported in this paper to conserve space.
First, the research conducted estimations in which dummy variables were included to capture
industry- and year-specific fix effect. The outcomes indicate that there is no important change on
major variables. To be specific, both total book debt ratio and total market debt ratio are
negatively associated with firm performance at the 1% level of significance. When there is a 1%
increase in total book debt ratio, the firm ROA, ROE and Tobin Q decrease approximately 0.1%,
0.2% and 0.2 units respectively, holding all other variables constant.
The research then uses the alternative measure of capital structure to test the robustness of the
original empirical model. Long-term debt and short-term debt based on book and market value
were used as proxies for capital structure instead of total debt ratios. In line with the previous
empirical results of this study, the coefficients of leverage in ROE, ROA and Tobin Q are all
negatively significant at the 1% and 5% level when using the proxy of long-term debts to market
value of total assets. Likewise, the coefficient of book leverage in the ROA equation is negative
and significant at the 1% level, respectively. These figures in ROE and Tobin Q equations are
insignificant under the proxy of long-term debts to book value of total assets. Similarly, the
results have the same sign as the original models, which use total debt ratios as proxies of capital
structure. The coefficients of leverage are significant and negative at 5% but the coefficients of
ROA and Tobin Q are insignificant. The results of other variables of growth rate, risk, liquidity
or dividend yield appear to be robust under different equations of capital structure proxies.
5.8 Non-linear relationship between capital structure and firm performance
Tests were conducted to determine the existence of a non-linear relationship between capital
structure and firm performance. The quadratic function that is underpinned by the work of
Berger and Bonaccorsi di Patti (2006) and Margaritis and Psillaki (2010) was used to allocate a
non-linear relation. The result reported in Table 13 shows that a non-linear relationship only
appears when performance is measured by ROE and capital structure measured by total and
short-term debt. The coefficient of debt ratio is positively significant and square of debt ratio
significantly negative in the ROE equation, but these coefficients are negative and insignificant
in ROA and Tobin Q regressions. This indicates that debt ratio is negatively related with ROA
and Tobin Q even at a high level. Meanwhile, at low levels, debt ratio is associated positively
with ROE; however, at a high level, the relationship switches from positive to negative. The
results could be due to ROE measured by ROA multiplied by financial leverage. At low levels,
an increase of debt ratio will increase ROE through rising financial leverage. However, an
increase of debt ratio also decreases ROA. Therefore, at a high level of debt ratio, when the
decline of ROA overwhelms the increase in financial leverage, ROE will reduce. It could be
concluded that capital structure generally negatively affects firm performance. In the special case
of ROE, the existence of a non-linear relationship between ROE and capital structure is simply
due to the usage of financial leverage.
[ Table 9 ]
6. Conclusion and discussion
This study provided evidence of capital structure negatively affecting firm performance.
Specifically, when testing the linear relation between leverage and firm performance, the finding
indicates that all ratios of long-term debt, short-term debt and total debt in both book and market
value are significantly and negatively related to ROA, ROE and Tobin Q. When allowing a non-
linear relation between capital structure and firm performance, the research shows that the non-
linear relation only appears when performance is measured by ROE and capital structure
measured by total debt and short-term debt. This outcome is consistent with the research of Tian
and Zeitun (2007), Joshua (2007) and Majumdar and Chhibber (1999) in the context of emerging
markets; however, it is not in accordance with most studies conducted in developed countries,
which posit a positive relationship between capital structure and firm performance. This may be
due to the stage of development and transition that Vietnam is currently at but suggest that
similar findings may be for similar countries in transition or in economic transition. So, this
paper argues that the traditional theories which work in western countries should be carefully
examined or adjusted when applying in emerging and transition markets like Vietnam.
The negative relationship found between capital structure and firm performance may be
explained by a few factors. As a transitional and emerging market, Vietnam may have unique
aspects when compared with other developed countries. First, although in the early 1990s
Vietnam initiated an economic reform programme that transferred the central planned economy
to a market economy, the financial system is underdeveloped (IFC 2007; Leung 2009). The
Vietnamese financial market is dominated by a banking sector in which SOCBs still control
deposit and credit markets. Majumdar and Chhibber (1999) argued that state-owned financial
institutions do not suffer from bad loan decisions made by their own principals as privately
owned companies do, because their owner, the government, theoretically always has deep
pockets. Therefore, the incentive for monitoring their customers in state-owned financial
institutions is not very significant. Thus, in the Vietnam context, the benefit of debt as a
monitoring manager to reduce the equity agency cost may be not substantial. Furthermore, from
the firms’ point of view, managers are aware of the debt monitoring inefficiency, so an increase
in debt can help them to acquire more cash to undertake discretionary investments, which
negatively affects firm performance.
Second, interest rates in Vietnam, both deposit and lending rates, increased sharply and to a
much higher level than other countries in the period from 2007 to 2011. Specifically, the deposit
and lending rates nearly doubled in 2011 compared with 2009 (Mirae Asset Securities 2011).
Therefore, interest payments have become a burden for most Vietnamese firms. Additionally, the
research shows that tax is not a significant determinant of capital structure decisions; in other
words, Vietnamese firms have not taken advantage of tax shields by issuing debt. Therefore, the
benefits of debt from tax saving overcome by the costs of debt including financial distress and
liquidity issues. Furthermore, Stulz (1990) argued that interest payments may exhaust firm cash
flow and reduce available funds for profitable investments, which negatively affects firm
performance. With the high interest rates, this may have occurred for Vietnamese firms.
In addition, as outlined in the data description, short-term debt accounts for most of the capital
structure of Vietnamese listed firms, which frequently occurs in developing countries. To be
specific, while the average long-term debt ratio is only 10.83%, the mean ratio of short-term debt
is 41.09%. Meanwhile, it is widely agreed that short-term debt pushes firms to the risk of
refinancing, thereby negatively affecting firm performance. Furthermore, a low ratio of long-
term debt implies a low level of long-term investment and thus low profit in the future.
Finally, McConnell and Servaes (1995) and Stulz (1990) posited a positive relationship between
firm performance and leverage in low-growth firms; conversely, firm performance is negatively
associated to leverage for those with high growth. A reasonable explanation is that a positive
effect appears in firms with fewer growth opportunities because an increase in debt prevents
managers from investing in unprofitable projects or reduces the overinvestment problem.
Conversely, in high-growth-opportunity firms, there is a negative effect of debt on firm
performance because an increase in debt forces managers to forego profitable projects or
increase the underinvestment issue. In contrast, high-growth firms are common in fast-growing
countries (Ruan, Tian & Ma 2011) and Vietnam is one of the world’s highest growth rate
countries (Deutsche Bank Research 2007; World Bank 2011). Therefore, a negative relationship
may exist between capital structure and firm performance in Vietnamese firms.
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Table 1: Control variables used in this study
Variables Measure
Growth (GRO) The percentage change in sales over the year
Tangibility (TAN) The ratio between fixed assets and total assets
The effective tax rate, which is calculated by dividing total taxes by the
Tax (TAX)
pre-tax income
The standard deviation of the ratio of operating income before interest,
Risk (RISK) taxes, and depreciation to total assets—this research used the previous
three years when calculating standard deviation
Investment (INV) The ratio of capital expenditure to total assets
Cash flow (CF) The ratio of earnings after taxes plus annual depreciation to total assets
Profitability (PRO) The ratio of earnings before interest and taxes to total sales
Liquidity (LIQ) The ratio of cash and cash equivalent to total assets
Dividend (DIV) Dividend per share over share’s market price
32
Table 3: Descriptive Statistics of capital structure (CS), firm performance (FP)
33
Table 4: Correlation coefficients between measures of capital structure and firm performance
ROA ROE Tobin Q TLEV MLEV GRO INV CF RISK LIQ DIV
ROA 1.00
ROE 0.4885* 1.00
Tobin Q 0.3450* 0.0912* 1.00
TLEV –0.4305* –0.1294* –0.1679* 1.00
MTLEV –0.5730* –0.1805* –0.4398* 0.8264* 1.00
GRO 0.1422* 0.0963* 0.1085* –0.0011 –0.0964* 1.00
INV 0.0371 0.0366 0.0358 0.0479* 0.0101 0.0910* 1.00
CF 0.6092* 0.2920* 0.2098* –0.1677* –0.2799* 0.0877* 0.1568* 1.00
RISK –0.0184 –0.1997* 0.1189* –0.1940* –0.2017* 0.0148 –0.0597* –0.0169 1.00
LIQ 0.3998* 0.1317* 0.1430* –0.3231* –0.3597* 0.0070 –0.0326 0.1595* 0.0443* 1.00
DIV 0.2584* 0.1516* –0.1616* 0.0096 0.1076* 0.0151 –0.0124 0.2091* –0.1366* 0.1284* 1.00
Note: ROA: the ratio of earnings after interest and tax to book value of total assets; ROE: the ratio of earnings after interest and tax to book value of total equity;
Tobin Q: the ratio of the firm’s market value to firm’s book value; TLEV: the ratio of total debt to book value of total assets; MTLEV: the ratio of total debt to
market value of total assets; GRO: growth rate measured by the percentage change in sales over the year; TAX: the effective tax rate, which is calculated by
dividing total taxes by the pre-tax income; Risk; INV: investment; CF: cash flow; LIQ: liquidity ratio; DIV: dividend yield.
34
Table 5: The effect of capital structure on firm performance—Pooled OLS regression
, = + , + , + , (14)
This table reports the results of examining the relationships between capital structure (CS) and firm performance,
which were estimated by pooled OLS estimators. Statistics are based on annual data for the years 2007–2012.
Columns 1 and 2 examined the effects respectively of total debt to book value of total assets (TLEV) and total debt
to market value of total assets (MTLEV) on return on assets (ROA). Columns 3 and 4 examined the effects
respectively of total debt to book value of total assets (TLEV) and total debt to market value of total assets
(MTLEV) on return on equity (ROE). Columns 5 and 6 examined the effects respectively of total debt to book value
of total assets (TLEV) and total debt to market value of total assets (MTLEV) on Tobin Q. There are six control
variables: firm growth (GRO), investment (INV), liquidity (LIQ), risk (RISK), dividend (DIV) and cash flow (CF).
Dependent variable: Dependent variable: Dependent variable: Tobin
ROA ROE Q
(1) (2) (3) (4) (5) (6)
TLEV –0.105*** –0.2047*** –0.254***
(0.005) (0.039) (0.075)
MTLEV –0.132*** –0.242*** –1.101***
(0.004) (0.036) (0.065)
GRO 0.0082*** 0.0053*** 0.0362*** 0.0309*** 0.0783*** 0.0555***
(0.001) (0.001) (0.008) (0.008) (0.016) (0.015)
INV –0.0061** –0.0057** –0.0148 –0.0144 –0.0108 0.0089
(0.002) (0.002) (0.018) (0.018) (0.035) (0.033)
CF 0.490*** 0.424*** 1.2883*** 1.171*** 2.252*** 1.460***
(0.012) (0.011) (0.093) (0.096) (0.176) (0.173)
RISK –0.120*** –0.157*** –2.2907*** –2.348*** 1.522*** 0.667*
(0.025) (0.024) (0.196) (0.195) (0.371) (0.345)
LIQ 0.170*** 0.130*** 0.2393*** 0.174** 0.774*** 0.0639
(0.010) (0.010) (0.082) (0.083) (0.156) (0.151)
DIV 0.119*** 0.182*** 0.3566*** 0.469*** –2.260*** –1.627***
(0.014) (0.013) (0.110) (0.112) (0.209) (0.202)
Constant 0.0519*** 0.0762*** 0.129*** 0.166*** 1.156*** 1.749***
(0.003) (0.003) (0.029) (0.029) (0.056) (0.053)
Observations 2625 2625 2625 2625 2625 2625
Adj R–squared 0.5930 0.6484 0.1615 0.1695 0.1327 0.2137
F-test 544.61 692.19 73.19 76.29 57.2 101.6
35
Prob > F 0.0000 0.0000 0.0000 0.0000 0.0000 0.0000
Standard error in parentheses: * significant at the 10% level; ** significant at the 5% level; *** significant at the 1%
level
36
Table 6: The effect of capital structure on firm performance—RE and FE regressions
, = + , + , + +
This table reports the results of examining the relationships between capital structure (CS) and firm performance measured by return on assets (ROA), return on
equity (ROE) and Tobin Q, which were estimated by random effect and fix effect estimators. Statistics are based on annual data for the years 2007–2012. There
are six control variables: firm growth (GRO), investment (INV), liquidity (LIQ), risk (RISK), dividend (DIV) and cash flow (CF).