Motivationoftheresearch
Vietnamisoneofthefewcountriesthatwas lessaffectedbytheglobalfinancial crisisin2 0 0 8 , andissaidtostillmaintaineconomicgrowthinapositiveway.However,more orl e s s , Vietnamisyetnotabletoavoidthenegativeimpactsofthisfinancialcrisisstorm; a s t h e p a n o r a m a o f V i e t nam’se c o n o m y h a s r e c e n t l y d e t e r i o r a t e d a n d s t a r t e d t o s l o w d o w n Inaddition,thepublic–debtcrisisinEurope alsocontributedtothegrowth ofourcou nt ry 'sGDPwiththeGDPintheperiodafter2008muchlowerthanthepre- crisiso n e A c c o r d i n g t o t heG e n e r a l S t a t i s t i c s O f f i c e ofVietnam,V i e t n a m ’ s G D P i n 2 0 1 4 increasedby5.98%,comparedtothisindicatorin2007,whichwas8.46%.
Besides,theh i g h i n f l a t i o n r a t e leads to tight monetarypolicyofcentralbanks,meanwhile,the suddenincreaseoflendingrateshasbroughtaboutnumerousdifficultiestothefirmsinrai singc a p i t a l toexpandtheireitherproductionorinvestmentforpotentialnewprojects
Vietnamese firms have become significant victims of the financial and public debt crises in Europe, facing challenges from global economic and political instability, as well as domestic issues like bad debts and low fund disbursement Many companies have struggled to maintain operations, leading to bankruptcy due to daily losses In response to this tough situation, numerous businesses have opted to restructure their capital, invest in alternative factors to minimize risks, and enhance production efficiency The primary focus for these companies is to improve performance and navigate the repercussions of the crisis, making it crucial to identify and understand the factors that impact firm performance.
Numerous studies have explored the factors influencing firm performance, particularly focusing on the relationship between free cash flow, capital structure, and firm diversification While economists have noted a strong correlation among these factors, their interactions remain contentious Modigliani and Miller (1958) initially claimed that capital structure does not impact firm value; however, their later work in 1963 indicated that capital structure does play a crucial role Research by Tang and Jang (2007) on the trade-off theory and Myers and Majluf (1984) on pecking order theory further examined the link between capital structure and firm performance Additionally, the relationship between leverage and diversification has been analyzed by Taylor and Lowe (1995), Kochhar and Hitt (1998), Markides and Williamson (1996), and LaRocca et al (2009) Despite these efforts, a comprehensive study examining the interplay of these four factors remains limited and underexplored.
Capitals t r u c t u r e , f r e e c a s h f l o w , d i v e r s i f i c a t i o n a n d firmp e r f o r m a n c e h a v e i m p o r t a n t implicationsinthesurvivalanddevelopmentofcompanies.Therefore,theresultsof thiss t u d y maybehelpfulforcompanieslistedonthestockmarketinparticularandViet namesecompaniesin generalin determiningthepropercapitalstructure,in linewithlong- termorientationofcompany,orusingthecashsensibly,avoidingthecashholdinge x p e n s e whilestillmaintainingtheabilitytoinvestinpotentialnewprojects.Moreover,t h e clari ficationoftherelationshipbetweendiversificationandfirmperformancewouldb e usef ulforcompaniesintheimplementationofdiversificationstrategiesinproductiono r busine ss.
Int h e w o r l d i n g e n e r a l a n d V i e t n a m i n p a r t i c u l a r , t h e r e w e r e a l o t o f studie sw h i c h r esear ch therelationshipbetweencapitalstructureandbusinessresultsin thecompany,b u t t h e r e l a t i o n s h i p b e t w e e n t h e s e f a c t o r s w i t h t h e d i v e r s i f i c a t i o n h a s n o t yetb e e n extensivelyresearched,thereforthisresear chfocusedontheinter-relationshipbetween capitalstructure,freecashflow,diversificationandfirmperformance,researchandfi ndo u t w h e t h e r t h e r e a r e a n y r e l a t i o n s h i p i n a h o l i s t i c s i t u a t i o n a m o n g t h e s e f a c t o r s i n Vietnamesecompanies.
Researchobjectives
Ino r d e r t o f i n d o u t t h e r e l a t i o n s h i p s b e t w e e n f i r m performance, c a p i t a l s t r u c t u r e , f r e e cash flowanddiversification,thestudyfocusontwogoalsbasically:
2,Whethertherelationship ofthesefourfactorschangewhentheyareputintoth er el a t i o n s h i p s withfinancialfactorsandthecompany'sstrategy?
Researchcontribution
The relationship between firm performance, capital structure, free cash flow, and diversification is crucial for companies An optimal capital structure can enhance firm value, ensure immediate investment capacity, and reduce bankruptcy risk Companies with positive and stable cash flow demonstrate excellent financial health, enabling them to fund potential projects without relying on external capital, thus maintaining a stable financial structure However, excessive free cash flow can lead to negative agency issues In today's volatile economic context, many companies are diversifying their production and business to maximize profits and minimize risks, though the effectiveness of diversification remains a significant question Understanding the interplay among these factors can provide a foundation for Vietnamese companies to develop sound fiscal policies and business strategies aimed at maximizing firm value This research will also contribute to the global discussion on the relationship between free cash flow, capital structure, diversification, and firm performance.
Structureoftheresearch
Chapter1:Introduction.Thischapterpresentsselectedtopicreason,researchobjectives,r e s e a r c h distributionandstudylayouts
Chapter2:Literaturereview.Thischapterpresentsthetheories andpreviousempi ricalstudiesabouttherelationshipamongthecapitalstructure,freecashflow,diversificat iona n d firmperformance,thefindings,debateaswellaslimitedinthesestudies.
Chapter4 : R e s u l t s T h i s c h a p t e r p r e s e n t s a n d d i s c u s s e s t h e r e s u l t s o f r e s e a r c h o n t h e r e l a t i o n sh i p betweenthecapitalstructure,freecashflow,diversificatio nandfirmperformanceinVietnam.
Chapter5:Conclusions.Thischapterpresentsthecontributionoftheresearch,thene xtr e s ea r ch andlimitationsofthestudy.
Thestudyoftherelationshipbetweenfirmperformance,capitalstructure,freecashflo w andd iversification
Capitalstructureandfirmperformance
PostulateI o f M o d i g l i a n i a n d M i l l e r ( 1 9 5 8 ) s u g g e s t e d t h a t t h e t o t a l s t o c k v a l u e o f a companycanbedeterminedonlybyrealproperty,thusdividingthecashint odifferentlinescannotchangethetotalvalueofsecuritiesofthatcompany.Thisalsomeansthatth ecapitals t r u c t u r e d o e s n o t a f f e c t t h e f i r m v a l u e H o w e v e r , t h e extend edp o s t u l a t e I , ModiglianiandMiller(1963)havereversedthisstatement.Consideringthe existingtax,t h e valueofthecompanyachievesmaximumlevelswhenitisfundedent irelybydebt.T her efo r e, tounderstandtherelationshipbetweencapitalstructureandfirmp erformance( r e p r e s e n t i n g thevalueofcompany),thissectionwilltakethethreetheories: Trade–offtheory,Pecking–ordertheoryandAgencytheoryintoconsideration.
The trade-off theory posits that companies must balance the benefits of tax shields against the costs of financial distress, as debt serves as a cheaper source of capital compared to equity However, a high debt ratio can increase the risk of financial exhaustion and bankruptcy Consequently, firms aim to establish a target debt ratio that optimizes the trade-off between tax deduction benefits and the costs associated with debt and bankruptcy The optimal capital structure is achieved when the marginal benefit of debt equals its marginal cost, thereby maximizing firm performance Moreover, the ideal debt ratio varies among companies; those with substantial tangible assets and taxable income should consider increasing their debt ratio to enhance tax shield benefits, while firms with predominantly intangible assets and lower profitability should focus more on equity financing.
In a 1983 study examining the role of theory in corporate capital structure research, the authors proposed seven hypotheses regarding the relationship between fixed assets, growth opportunities, and long-term debt They found that fixed assets and growth opportunities positively influence long-term debt, and the interaction between these two factors also has a positive effect Additionally, income volatility negatively correlates with long-term debt, while firm size and agency costs positively impact long-term debt levels Conversely, profitability demonstrates a negative relationship with long-term debt Analyzing data from 27 hotels and 27 software companies between 1997 and 2003, the results indicated positive impacts of fixed assets and growth opportunities on long-term debt in hotel companies, while a negative relationship was observed in software companies.
A study conducted from 1962 to 1981 analyzed data from 851 companies across 25 different industries to investigate the trade-off theory of optimal capital structure The authors reviewed previous research and developed an empirical model that incorporated individual investor taxes, expected financial distress costs, and non-debt tax deductions They proposed seven hypotheses related to investor risk preferences and environmental taxes affecting capital structure decisions and corporate bankruptcy prevention Using Analysis of Variance (ANOVA) with industry dummy variables, the study provided evidence supporting the trade-off theory The findings revealed a negative relationship between a company's optimal leverage and expected financial distress costs, as well as non-debt tax benefits, while also indicating that optimal financial leverage negatively correlates with corporate income in the presence of anticipated financial distress.
Kester(1986),TitmanandWessels(1988),RajanandZingales(1995)alsogaveempiri calevidenceprovingnegativerelationshipbetweenleverageandfirmperformance.R a j a n andZing ales(1995)studiedthechoiceofthecapitalstructureofthecompaniesintheG-
7c o u n t r i e s ( t h e U n i t e d S t a t e s , J a p a n , Germany,t h e U n i t e d K i n g d o m , F r a n c e , C a n a d a , andItaly).Theauthorscollected datafromthe4,557non- financialcompaniesw h i c h belongtothemainindustrygroupsinthesecountriesinthe periodof1987-1991r epo rt ed in Global Vantage,then sortthembasedon thefinancial indicatorsin
In 1991, the authors measured leverage through four different methods: first, by defining it as the ratio of non-equity liabilities to total assets; second, by calculating it as debt divided by total assets; third, by measuring the value of debt to net assets; and fourth, as the ratio of debt to capital The authors chose multiple definitions of leverage due to the absence of consolidated balance sheet reporting in some countries, significant differences in asset appraisal across nations, and variations in balance sheet structures Their research compared the mean leverage of different countries, revealing minimal differences in capital structure decisions The authors estimated an equation with leverage as the dependent variable, and independent variables included fixed assets, firm performance, firm size, and corporate profitability Results indicated a positive relationship between fixed assets, firm size, and leverage, while market-to-book ratios and profitability negatively impacted leverage The authors explained the inverse relationship between leverage and firm performance using trade-off theory, suggesting that companies with high market-to-book ratios face increased financial distress costs, leading them to reduce financial leverage as a precaution.
According to the pecking-order theory, managers are more aware of the company's value and potential risks than investors, leading them to prefer financing investments first with retained earnings, followed by safe debt, risky debt, and ultimately issuing new shares Myers and Majluf (1984) argue that there is no optimal capital structure for a company, as investors often seek to reduce the price of newly issued shares, aligning with managers' forecasts To avoid negative perceptions regarding investment decisions, managers favor internal funds over external sources like debt or new equity The pecking-order theory also suggests that tax shields are a secondary consideration, with the debt ratio fluctuating based on the balance between internal cash flow, dividends, and real investment opportunities Companies with high profitability typically utilize less debt leverage compared to others in similar investment scenarios Additionally, Myers and Majluf indicate that companies consider both current and future investment costs to accumulate cash for new opportunities without incurring high-interest debt or issuing more equity Consequently, firms with strong investment potential maintain lower debt ratios, reflecting a negative relationship between profitability and debt leverage Ross (1997) highlights that companies with high debt levels signal to investors that their future cash flows are of high quality, suggesting that only well-performing companies can manage their debt effectively Thus, if a company must issue new equity due to insufficient cash flow to cover its debt, it sends a negative signal to investors.
Finally,accordingtoagencytheoryofJensenandMeckling(1976) andJensen(1986) ,thereisa c o n f l i c t b e t w e e n managersa n d s h a r e h o l d e r s o r i n v e s t o r s W henf i n a n c i a l e x c e s s e s exist,m a n a g e r s e a s i l y t e n d t o p u r s u e p e r s o n a l g o a l s , w a s t i n g f r e e c a s h f l o w r a t h e r thanusingthemasefficientlysuchasinvestinginp oor-qualityprojectsevenitmightreducethevalueofcompany.Thisiscalledover– investmentproblem.Toreducetheo v e r – i n v e s t m e n t problem,t h e p o w e r o f managersi n d e t e r m i n a t i o n inc a s h f l o w s h o u l d b e l i m i t e d t h o u g h t b o r r o w i n g d e b t
D e b t f o r c e companiest o p a y c a s h , t h u s r e d u c i n g theamountofcashheldint hecompany Agoodlevelofdebt islevelwhereafterpayouttheinteresttocreditors,t hecompanywillbeonlyenoughmoneytoinvesti n projectswithpositiveNPV.Therefore,age ncymodelsexplainthepositiverelationshipb e t w e e n leverageandfirmperformance.
Besidet h e s e a b o v e t h e o r i e s , t h e r e l a t i o n s h i p b e t w e e n c a p i t a l s t r u c t u r e a n d firmperformanceisalsoreflectedthroughtherelationshipbetweenTobin'sqanddebtlever age.SmithandWatts(1992)startedacontroversywhentheysaidthatTobin'sqisa n exoge nousvariablewhileleverageistheendogenousvariable.McConnellandServaes( 1 9 9 5 ) didnotag reewiththisconclusionandconfirmedthatleverageisanexogenousv a r i a b l e a n d T o b i n ' s q i s a n e n d o g e n o u s v a r i a b l e M e a n w h i l e , s t u d i e s o f R a j a n a n d Zingales( 1 9 9 5 ) , D e m s e t z a n d V i l l a l o n g a ( 2 0 0 1 ) , D e J o n g ( 2 0 0
( 2 0 0 4 ) haveconsideredbothvariablesareendogenous,i.e.theinteractionbetweentheset w o variables,sothatthecapitalstructurehasanimportantinfluenceonthefirmperformancea ndopposite,firmperformancealsohasanimpactonthecapitalstructure.H a r v e y e t a l
( 2 0 0 4 ) s t u d i e d t h e e f f e c t o f ofd e b t o n t h e r e d u c t i o n inthea g e n c y a n d i n f o r m a t i o n problem.Theauthorsconsiderinteractioneffects,i.e.theendogenousrel atio n sh ip betweendebt,theownershipstructureandcorporatevalue.Theauthorhasc l a r i f i e d thisrelationshipbytworegressions:Cross- sectionalanalysistotesttheroleofdebtinmitigatingthereductionincorporatevalueinthe companywiththeseparationofm a n a g e m e n t c o n t r o l r i g h t s a n d o w n e r s h i p r i g h t s o f t h e c a s h f l o w , thismeansw h e t h e r leveragecanbeusedtoreducethenegativeimpact oftheagnecyproblemoncorporatevalu e S e c o n d , t h e e v e n t - s t u d y a n a l y s i s f o u n d e v i d e n c e a b o u t t h e d i f f e r e n c e s i n t h e abnormal r e t u r n s a s s o c i a t e d w i t h d e b t i s s u e d i n d i f f e r e n t m a r k e t s F o r c r o s s - s e c t i o n a l analysis,t h e a u t h o r s c o l l e c t e d d a t a from1 , 0 1 4 e x c h a n g e l i s t e d n o n - f i n a n c i a l firmsi n e i g h t e e n emergingmarketsin1995-
1996.Experimentalresultsshownthatdebtlessenedther e d u c t i o n i n firmv a l u e t h a t f o l l o w a s e p a r a t i o n b e t w e e n a m a n a g e m e n t g r o u p ’ s controlrightsandits proportionalcashflowownership.Fortheevent- studyanalysis,thea u t h o r s useddataof547exchangelistednon- financialfirmsintwentyemergingmarketsinWorldscpoeo v e r t h e p e r i o d o f 1 9 8 0 -
1 9 9 7 T h e a u t h o r h a s d e m o n s t r a t e d t h a t t h e internationalloansearnpositive cumulativeaberrantreturns.Thesecumulativeaberrantr e t u r n s a re p o s i t i v e a f f e c t e d o n t h e s e p a r a t i o n o f c o n t r o l a n d o w n e r s h i p T h i s positiver e l a t i o n isfocusedon firmswithahighlevelofassetsorlessgrowthopportunities.Initialissuesofpublicinternation albondsledtosignificantaberrant returns,butthesereturns aren o t matchedw i t h managemento w n e r s h i p s t r u c t u r e s T h e r e f o r e , t h i s r e s e a r c h determindedt h e s e t w o v a r i a b l e i n t h e e n d o g e n o u s r e l a t i o n s h i p , i t mean st h a t c a p i t a l structureandfirmperformanceinteractedtoeachother.
Freecashflowhypothesis
AccordingtoLehnandPoulsen(1989),operatingcashflowofassetsisusedasatooltomeasur ethefreecashflow.Accordingly,freecashflowissimplytheexcesslevelofcashf l o w However,t hismethodrevealedmanyweaknessessuchasnottakingintoformulatheinvestmento pportunitiesofthecompany.AccordingtoBrushetal.
(2000),freecashfl ow onlyappearwhenTobin'sqissmallerthanonei.e.whenit,thecompany hasalacko f profitabilityinvestmentopportunities.Brushetal.
(2000)suggestedthatthefreecashf l o w i s e x i s t i n g i f ando n l y i f companiesh a v e f e w e r o p p o r t u n i t i e s t o d e v e l o p T h i s methodissomewhatimproved whencal culatingadditionalinvestmentopportunities ofcompaniesinfreecashflow.However,i thasadefectthatcannotcombinetheinvestmentw i t h c u r r e n t a s s e t s , w h i c h meanst h a t a c o m p a n y h a s f e w e r i n v e s t m e n t o p p o r t u n i t i e s s h o u l d focusontheircoreb usinessbyinvestincurrentassets.AccordingtoArslanandK a r a n (2007),freecashflo wisestimatedasthedifferencebetweenoperatingcashflowan dc a p i t a l e x p e n d i t u r e s d i v i d e d byt o t a l a s s e t s Ana d v a n t a g e o f t h i s methodi s thatc a p t u r e thecompan y'sinvestmentsdirectly.However,itsshortcomingsareignoredc ap it a l e x p e n d i t u r e s i n c l u d e i n v e s t m e n t s i n e x i s t i n g a s s e t s a n d n e w i n v e s t m e n t o p po r t u n i t i e s , socashflowisestimatedbythismethodcouldbedepreciation.Zhaoetal.
( 2 0 0 9 ) haveimprovedmethodsofArslanandKaran(2007)togivethenewformulato measurefreecashflow.Accordingly,freecashflowisdefinedasthedifferencebetweeno p e r a t i n g c a s h f l o w a n d c a p i t a l e x p e n d i t u r e p e r c a p i t a i n t h r e e yearsd i v i d e d byt o t a l a s s e t s toseizetheoptimalinvestment.Howeverthisisalsoaformofextensionmethods o f ArslanandKaran(2007),ithasnotbeenfullyresolvedtheweaknessofthismethod.
To address the limitations of previous methods, Richardson (2006) introduced a new definition of free cash flow, aiming to explore its impact on over-investment in companies The primary hypothesis of the research suggests that companies with positive free cash flow tend to over-invest Richardson defines free cash flow as the surplus cash remaining after maintaining existing assets and funding anticipated future projects Over-investment, on the other hand, refers to investment expenditures that exceed the necessary funding for maintaining existing assets and pursuing new projects with a positive net present value (NPV) The total investment expenditure includes costs for maintaining existing assets, expected investments in new projects, and any over-investment in those new initiatives.
TheauthoralsogivestheformulaforcalculationofFreeCashFlowisthesubtractionofCashF lowgeneratedfromassetsinplace(CFAIP)andExpectednewinvestment(I*NEW).Where,CFAIP i s c a l c u l a t e df r o m Cashfromo p e r a t i n g a c t i v i t i e s (CFO)minusMaintenanceInvestm entExpenditure(IMANTENENCE)plusResearchandDevelopmentE x p e n d i t u r e (R&D).
Toe s t i m a t e t h e c a s h f l o w fromt h e g r o w t h o p p o r t u n i t i e s , R i c h a r d s o n ( 2 0 0 6 ) u s e d t h e e x p e c t e d investmentonnewprojectsandfirmlevelinvestmentdecisionmodel ofHubbard( 1 9 9 8 ) T h i s methodmays e e m c o m p l i c a t e d b u t i t i s t h e mostr e a s o n a b l e methodtodeterminefreecashflowbecauseitconsidered allthecomponentsof freecashf l o w at the companylevel.The authors haveusedpool withHuber-White standard errorsr e g r e s s i o n f o r s a m p l e d a t a i n c l u d e 5 8 , 0 5 3 f i r m - y e a r o b s e r v a t i o n s d u r i n g t h e p e r i o d o f
A study conducted in 2002 explored the relationship between free cash flow and over-investment, revealing that companies with excess free cash flow are more likely to over-invest, particularly when they have substantial additional cash The research categorized companies into two groups based on their free cash flow status—positive and negative It was found that firms with positive free cash flow allocated a significant portion of it to over-investment (20%) and retained financial assets (40%) In contrast, companies with negative free cash flow primarily directed their resources towards shareholder payments (37%) and bondholder payments (31%) Furthermore, the analysis indicated that incorporating shareholders into corporate management can help mitigate over-investment tendencies.
A study conducted in 2000 found that cash flows positively impact firm growth, yet there is a negative relationship between free cash flow and firm growth The research examined how free cash flow influences sales growth and overall firm performance, considering the effects of corporate governance strength Two main hypotheses emerged: companies with high free cash flow but weak governance experience high sales growth, while increased sales growth enhances firm performance Six hypotheses were proposed, including the negative impact of sales growth on firm performance and the moderating role of governance in the relationship between free cash flow and performance The study utilized data from Compustat, analyzing 1,570 firm-year observations from 1988 to 1995 Results indicated that while cash flow positively affects sales growth, excessive free cash flow can diminish company value, with varying impacts based on governance strength.
(2004) alsodemonstrated thatstockreturns ofco m p a ny int h e f u t u r e w i l l d e c r e a s e i f t h e c o m p a n y h a s t o o m u c h f i n a n c i a l e x c e s s Similarresultsarea lsogivenbyDechowetal.
Free cash flow, as defined in 2008, consists of three key components: the change in cash balance, net cash distributions to shareholders, and net cash distributions to debtholders Positive or negative free cash flow can arise from fluctuations in cash balances or contributions from shareholders and bondholders, influenced by factors such as the issuance of new equity shares or debt, and changes in dividend or interest payment policies The study presented three predictions: first, that cash flow from retained earnings is more volatile than capital from equity and debt; second, that cash flow from equity is more stable than cash flow from debt; and third, that expected returns from stock prices do not fully reflect the high volatility of cash from retained earnings compared to the more constant cash flow from equity The research analyzed a comprehensive dataset comprising 237,673 firm-year observations, with detailed financial statement data and 155,280 firm-year observations that included stock return data from 1950 onward.
2003.Theauthorsusedannualizedr e g r e s s i o n s f o l l o w i n g t h e a p p r o a c h o f Fama a n d M a c b e t ( 1 9 7 3 ) t o c l a r i f y thesepredictions.Theresultsindicatedthatthepredict ion1and2areabsolutelyrightinb o t h c o m p a n i e s w i t h n e g a t i v e o f p o s i t i v e freec a s h f l o w H o w e v e r , t h e e x p e r i m e n t a l re su lt s werenotconsistentwiththethir dpredictionwasthattheinvestorssimplyfixateo n earningsandfailtotellthedifferen cebetweenaccrualsandcashflows.Inaddition,t h e authorsalsosaidthatifcompanyha salargepositivefreecashflow,itwouldspendthemostofthemtoitsfutureinvestmentwhic hcangainthelowermarginalprofitabilitya n d thereforewhichwouldreducethecompanyvalue.
Therefore,reducingthefreecashflowwillincreasethefirmvaluethroughthereductiono f a g e n c y c o s t s I n o r d e r t o r e d u c e f r e e c a s h f l o w , c o r p o r a t e r e s t r u c t u r i n g f u n d s w i t h h i g h e r ratioofdebt,itmeansthattherepaymentobligationsalsoincreased,le adtothereductioni n cash h o l d i n g s , thereby reducing p o w e r o f t h e m a n a g e r s i nt h e in ves tme nt decision.Thisconfirmsthattheleveragereducesfreecashflow.ParkandJa ng(2013)intheir study also foundthe negativerelationshipbetweenleverageandfreecashflow.
Diversificationdiscountandfreecashflow
Thed i v e r s i f i c a t i o n strategyca n b e d i v i d e d i n t o t w o f o r m s : r e l a t e d d i v e r s i f i c a t i o n a n d u n rel ated d i v e r s i f i c a t i o n W h e n a c o m p a n y i m p l e m e n t s t h e r e l a t e d d i v e r s i f i c a t i o n strategies,thecompanywillinvestinthenew businessw h i c h hasmo recharacteristics similarand familiarwith thecorebusinessofcompany.Althoughinvestinginadifferentindustry,c o m p a n y c a n s h a r e c o s t s a n d t e c h n o l o g y w i t h i t s c o r e b u s i n e s s C o n v e r s e l y , w h e n companyinv estsinacompletelydifferentindustry;thereisnosimilarandfamiliar orobviousconnectionwiththecoreoperationsofthecompany,itcallunrelatedd i v e r s i f i c a t i o n
Diversificationd i s c o u n t s i s d e f i n e d t h a t v a l u e o f c o m p a n y o r c o m p a n y p e r f o r m a n c e d e c l i n e d afterthecompanyimplementedadiversificationstrategy.T heresearcherssaidt h a t t h e c a u s e o f t h e d i v e r s i f i c a t i o n d i s c o u n t c a n b e agenc yp r o b l e m L a n g a n d S t u l z ( 1 9 9 4 ) , BergerandOfek(1995),CommentandJarrell(19 95)studiedandprovideevidence tosupportthefreecashflowhypothesisofJensen(1986)for thediversificationd i s c o u n t Thus,agencytheoryalsoprovidesanexplanationforwhydi versificationmayb e beneficialformanagersbutreducethevalueofthecompany.Finkel steinandHambrick(1996)showedasignificantcorrelationbetweendiversificationan dcompanysizeandbetweendiversificationandmanagementcompensation.According tothea u t h o r s , managersoftenwish topursue diversificationasawaytoincreasecompensationforthemselvesandconsolidatetheirpositi on;evendiversificationstrategiescanreduce thefirmvalue.
According to Rumelt (1974, 1982), unrelated diversification tends to lower firm performance compared to related diversification, as it requires significant initial investments and carries higher risks, ultimately detracting from firm value Villalonga (2004) provided evidence that unrelated diversification leads to a devaluation of companies, while related diversification often results in a premium The author criticized previous studies for using data from the Compustat database, arguing that it produced inaccurate results and did not fully explain the impact of diversification on firm performance Villalonga identified three main reasons for this: first, the degree of separation in financial statements was less than the actual level of diversification; second, the definition of segmentation led to a misrepresentation of diversification in reports.
Standard( S F A S ) 1 4 d e f i n e d segmentsa s p a r t o f t h e c o m p a n y e n g a g e d i n p r o v i d i n g p r o d u c t s a n d s e r v i c e s t o u n a f f i l i a t e d c u s t o m e r s g r o u p f o r a p r o f i t A c c o r d i n g l y , iti s u n d e r s t a n d a b l e SFAS14definessegmentoperatingasanu nrelateddiversificationofthecompany.Third,companymightchangeitsreportaboutitssegme nt,althoughthereweren o realchangesinitsoperations.Tofindouttheanswertothe questionwhethersegmentd at a increaseddiversificationdiscountthanotherdatasources; theauthorsusedthedataf r o m t h e
The Business Information Tracking Series (BITS) analyzed results against previous studies using segment data from Compustat The research defined a business establishment as a single physical area where a company operates or provides services, grouping firms with the same SIC codes into business units The author implied that companies have the option to pursue both unrelated and related diversification strategies By estimating the excess value of diversified companies compared to non-diversified firms, and conducting robust checks to validate findings, the author concluded that unrelated diversification typically results in a discount, while related diversification offers a premium This phenomenon may stem from the notion that unrelated diversification arises from over-investment due to financial excess Supporting this, Doukas and Kan (2004) confirmed a direct link between diversification strategy discounts and free cash flow They suggested that if managers perceive high free cash flow, they might invest in projects with negative NPV, potentially leading to both related and unrelated diversification Although unrelated diversification can yield more advantages for managers, they are often drawn to related diversification due to familiarity with their core business areas Thus, the conclusion is that diversification strategies—whether related or unrelated—have significant implications for company value and management decisions.
18 diversificationstrategybecauseoftheblockfrominvestorsinordertoprotectfirmvalue.I n summ ary,t h e d i f f e r e n t r e s u l t s o f p r e v i o u s studiesm a y beduetot h e i n s p e c t i o n o f d i v e r s i f i c a t i o n discountseparately,butisnotassociatedwithotherfactors.
(2003)studiedaconceptual modeloraprocesstoimprove f i r m performancethroug hcompetitive advantage fromdiversification Theauthors saidthatr e l a t e d div ersification(concentricdiversification)broughtmorebenefitstocompanythano t h e r typesofdive rsification,butthecompetitiveadvantageofthecompanywhichcamef r o m diversificationw erealsoquicklybeingcopiedbythecompetitorsandtherebylosesi t s i n h e r e n t a d v a n t a g e s T h e a u t h o r s p o i n t e d o u t t h a t , t o e n s u r e t h e s u s t a i n a b i l i t y o f co mpetitiveadvantage,companyneedtobuildthebarrierstopreventtheimitationsofthec o m p e t i t o r s , inparticular,thesebarriersbestpromotedefficiencywhentheywerebuiltass o o n a s c o m p a n y b e g a n t o d i v e r s i f y o r c a p t u r e p o t e n t i a l b e n e f i t s f r o m d i v e rs i f i c a t i o n , mean while,thecompetitorscouldnotcatchupwithorunderstandthesourceofcompetitivea dvantage.Intermsofthemotivationofdiversification,Rijamampianinaetal.
Theauthorspointedoutthatasuccessfuldiversificationstrategy,whichhadthreeofthef o l l o w i n g inheritancethestrengthfromthecorebusiness,diversificationintoareaswhichcloset o t h e c o r e b u s i n e s s a n d i m p r o v i n g t h e s k i l l s fromt h e c o r e b u s i n e s s , h e l p e d co m p a n y increasecompetitiveadvantage,therebyimprovi ngfirmperformance.Finally,t h e authorsofferedaconcepturemodelincludes4stepstoe
19 xpresstheimpactofd i v e r s i f i c a t i o n onperformance.Step1:diverseresourcestocreatecompet itiveadvantage.
Step2 : t h e c o n s t r u c t i o n o f t h e b a r r i e r s t o i m i t a t i o n c r e a t e d s u s t a i n a b l e c o m p e t i t i v e a d v a n t a g e Step3:thedevelopmentinsustainablecompetitive advantagemadetheeffectiveconcentricdiversification Andfinally,step4:effectiv erelateddiversificationwouldi m p r o v e f ỉmperformance R i j a m a m p i a n i n a e t a l.
( 2 0 0 3 ) m a d e thesemotivationcomesf r o m t h e l e v e l o f f i r m p e r f o r m a n c e I t me anst h a t d e p e n d i n g o n h i g h o r l o w performing,companychoosethediversifyformsand degreeofdiversification.Therefore,b a s e d ontheaforementionedstudiesandtheoriesofd iversificationmotives,wecanseethatthereareanendogenousrelationshipbetweendive rsificationandfirmperformance.P a r k andJan g (2013) bycollecting andana lyz in g d a t a from 308r est au ran t companies gavethee v i d e n c e t h a t d i v e r s i f i c a t i o n i sa m p l i f i e d byf r e e c a s h f l o w S i m u l t a n e o u s l y , e v i d e n c e alsoprovidesaconc lusionthatrelateddiversificationincrease firmvalueandb e t w e e n relateddivers ificationandfirmperformancehaveanegativeendogenousr e l a t i o n s h i p
Therelationshipbetweendiversificationandcapital structure
Thec o - i n s u r a n c e e f f e c t s a i d t h a t c a s h f l o w v o l a t i l i t y c a n bemitigatedbyt h e i m p l e m e n t a t i o n ofdiversification,andminimizethedifferenceofthecashflowswillleadt h ecomp any'sdebtincrease Inaddition, th e incomefromrelateddiversification compan ycorrelatedmorestronglythantheincomestreamfromunrelateddiversificationcompany.T h e n , c o - i n s u r a n c e e f f e c t c a n e x p l a i n t h e c o r p o r a t e d e b t l e v e r a g e i n r e l a t e d d i v e r s i f i c a t i o n firmw i l l b e smallert h a n i n u n r e l a t e d d i v e r s i f i c a t i o n f i r m B e r g e r a n d O f e k (1995),Lawenllen(1971),KimandMcConnell(1977)found outtheevi dencetosupportthetheory.B e r g e r a n d O f e k ( 1 9 9 5 ) e x p l o r e d t h e relationshipb etweend i v e r s i f i c a t i o n a n d firmv a l u e byc o m p a r i n g t h e t o t a l v a l u e o f e a c
20 h s e g m e n t s o f t h e d iv er sifi ed companyto the actualvalue of thiscompany.Theauthors used dataincluding3 , 6 5 9 firmswith16,181observations,ofwhich5,233aremulti- segmentintheperiodof1 9 8 6 -
During the studied period, 20 companies with total sales exceeding $20 million and no segments in the financial services industry were analyzed Each segment of these diversified companies was required to generate at least 1% of total sales The authors calculated the imputed value of each segment by applying the median ratio of total capital to one of three accounting items (assets, sales, or EBIT) from non-diversified companies in the same industry They then estimated the percentage difference between company values and segment totals to assess the impact of diversification on corporate value The results indicated that diversification consistently diminishes firm value across all estimations, regardless of company size The authors attributed this loss to two main factors: overinvestment leading to decreased company value and cross-subsidization, where higher prices charged to one customer group offset lower prices for another Additionally, the study found that diversified firms with negative cash flow segments had significantly lower values compared to those without However, related diversification was shown to enhance company value when using asset and sales multipliers, which the authors explained through the co-insurance effect, allowing diversified companies to benefit more from tax shields by increasing their debt ratios.
21 t h e sametime,t h e s e c o m p a i e s a l s o t o o k morea d v a n t a g e oftaxbenefitswhe nusingthelossinthissegmenttooffsetprofitsfromothersegments,therebyreducingthetax payable.However,theauthorsalsopointedoutthat theb e n e f i t s fromt h e t a x s h i e l d i n t h e d i v e r s i f i e d c o m p a n i e s withh i g h d e b t r a t i o i n c ap it a l structurewerenotlarge.Ontheotherhand,MajdandMyers(1987) alsoarguedthattheincreaseindebtthroughdiversificationcancontributetoimprovi ngfirmperformancebygainingbenefit fromthetaxshi el d Thediversificationfirm withhighd e b t l e v e r a g e w i l l t a k e a d v a n c e f r o m t h e b e n e f i t s o f t a x d e d u c t i o n s t h a n t h e o t h e r co mpet it or s whichdonotuseoruselessleverage.
TransactioncostshypothesisofMarkidesandWilliamson(1996)arguedthatadecisiono ncapitalstructurewhichtheratioofdebtandequityisdeterminedbythecharacteristicso f t h e c o m p a n y a s s e t s T h e h y p o t h e s i s suggestedt h a t t h e s p e c i f i c a s s e t s s h o u l d b e f i n a n c e d by equityandviceversanon- specificassetsshouldbefinancedbydebt.Accordingly,s p e c i f i c a s s e t s , r e l a t e d t o r e l a t e d d i v e r s i f i c a t i o n s h o u l d b e f i n a n c e d bye q u i t y becausetheyarelimi tedintermsofliquidity,thedifficultyofliquidationwhenthec o m p a n y wentbankrupt.Incontras t,generalproperty,involvingunrelateddiversifications h o u l d befinancedbydebtastheyaree asilyliquidatedintheeventofbankruptcyandalsohastheabilitytouseascollateral.Thi sleadstotheconclusionthatrelatedd i v e r s i f i c a t i o n w i l l r e d u c e l e v e r a g e w h i l e unrelateddiversification willincreasetheleverageofthecompany.
Jensen and Meckling (1976) contributed to the discussion on the relationship between leverage and diversification through agency theory They noted that debt can limit managerial power in investment decisions by reducing free cash flow, which in turn affects diversification strategies, particularly unrelated diversification As a result, shareholders often prefer using debt as a means to control managers and protect firm value from investments in unrelated industries Additionally, Li and Li (1996) argued that companies with low debt leverage may experience over-investment in diversification Therefore, diversification firms should maintain a higher debt ratio compared to non-diversified companies to mitigate the risk of over-investment While agency theory suggests that increased leverage will diminish unrelated diversification, the impact on related diversification remains uncertain.
Amita and Livnat (1988) explored the relationship between diversification, capital structure, and risk using path analysis, concluding that diversification minimizes risks but increases debt leverage to capitalize on tax deductions Ruland and Zhou (2005) posited that while diversification may negatively impact firm value, it can also enhance firm value indirectly through increased financial leverage Their study utilized Compustat data to investigate the effect of leverage on the value of diversified firms, hypothesizing that leverage boosts value in diversified companies but not in non-diversified ones Drawing on Berger and Ofek (1995), they developed an empirical model with excess value as the dependent variable, analyzing various independent variables, including diversification and leverage The final sample comprised 48,773 firm-year observations, focusing on diversified firms from 1990 to 2001 The authors employed regression techniques to address estimation errors and endogeneity issues, finding that diversification generally reduced company value, while leverage increased value for diversified firms but harmed specialized firms They attributed these findings to agency problems, suggesting that diversified companies with high free cash flow might invest in less effective projects compared to specialized firms, with high debt ratios reducing agency costs Additionally, Park and Jang (2013) found that unrelated diversification increases leverage but did not find evidence supporting the same for related diversification, instead noting that high debt leverage decreases related diversification.
Summarizethepreviousstudiesabouttherelationshipbetweenthecapitalstructure,freecashf low,diversificationandfirmperformance
Therelationshipsbetweenfirmperformance,capitalstructure,freecashflowandd i v e r s i f i c a t i o n havebeenstudiedcarefully.However,thesestudiesareconsideredtho sef a c t o r s inisolationandindependently Thereisalackofresearch focusedont helinksbetweenthefourfactorsholisticallyandcomprehensively.
The relationship between capital structure and firm performance is elucidated through three primary theories: trade-off theory, pecking order theory, and agency theory According to Tanga and Jang (2007), the trade-off theory posits that companies establish a target debt ratio, weighing the benefits of tax shields against the costs of bankruptcy Meanwhile, Majluf and Myers (1984) introduced the pecking order theory, which highlights how asymmetric information between investors and managers creates a hierarchy in funding sources, prioritizing internal capital like retained earnings, followed by debt, and finally new equity issuance.
Free cash flow significantly impacts diversification strategies Berger and Ofek (1995) documented that investors often seek to invest in other industries to mitigate excessive free cash flow within a company However, these diversification efforts can negatively affect firm value, a phenomenon known as the "diversification discount." The origins of this discount are debated; Doukas and Kan (2004) suggest that both related and unrelated diversification lead to this discount, while Villalonga (2004) argues that only unrelated diversification decreases firm value, asserting that related diversification can enhance a company's value Additionally, Rijamampiana et al contribute to this discussion.
There are three key theories regarding the relationship between diversification and capital structure: the co-insurance effects, transaction cost theory, and agency theory The co-insurance effects, as proposed by Berger and Ofek (1995), suggest that diversification can enhance debt leverage, subsequently reducing cash flow volatility Transaction cost theory, highlighted by Markides and Williamson (1996), emphasizes that asset characteristics are crucial in making capital structure decisions Lastly, agency theory, introduced by Jensen and Meckling (1976), argues that increased debt leverage may limit managers' investments in both related and unrelated diversification projects, thereby reducing risks for investors and curtailing managerial power.
AmitandLivnat(1988)testedtherelationshipbetweendiversificationandcapitalstructu rea n d s y s t e m i c riskusingpatha n a l y s i s R e s e a r c h h a s f o u n d t h a t c o m p a n i e s minimizetheirrisksthroughtheimplementationofdiversification,butatthesa metimeincreasedleverageforthetaxdeductionsbenefit.However,thestudycouldnotpro vided e t a i l s abouttherelationshipofeachdiversificationstrategiestothefirm.ParkandJ ang
(2013)hascollecteddatafrom308restaurantcompaniesandusingaholisticanalysistoi d e n t i f y therelationshipbetween thefourfactorsfirmperformance,capitalstructure,freec a s h flowandfirmdiversification.T heauthorshavefoundevidencesuggestingthatthed i v e r s i f i c a t i o n discounts indiversified companiesarenot derived fromthefreecash flowb u t havenegativeeffectonfirmperformance.Thepaperalsosupportsthefreecashflowh ypothesiswhenarguedthatalargefreecashflowincreasesinvestmentinbothrelateda n d u n r e l a t e d d i v e r s i f i c a t i o n T h e b a l a n c e o f d e b t h e l p s t o r e d u c e f r e e c a s h f l o w , a n d en han ce firmvalue.
No Author Methods Data Mainfindings
OLS) regressionan dGeneralized leastsquaresa nalysis
Inlogingfirms,fixedassets,growt hopportunities,andtheinter- relationshipbetweenthesetwovaria bleshadpositivesignifi cant effec tonfirm’s long-termdebtbehavior
AnalysisofVa ri ance (ANO VA) forcross- sectional
851firmsin25indust riesfrom1962to198 1fromAnnualCom pustat
Optimalleverageofthecompanies hadanegativerelationshipwitht heexpectedcostofthefinancialdist ress,andnon- debttaxbenefits.Atthesametime,t heoptimalfinancialleveragealsoi nverselyr el ated tocompaniesinc omeifconsideringthecostofthefin ancialdistress
Thesefactorsimpactonthecapita lstructuredecisionsamongtheG-7countriesweresimilar.Tangibleas setsandfirmsizehadapositiveimp actonleverage.Conversely,Marke ttobookandprofitability hadanegativerelationshipwithleve rage.
- Iftheinvestmentrequiredexceed edtheabilityofcashandlow- riskdebt,companiesshouldignorei nvestmentprojectsrat h er thaniss uingnewequity
- Ifthemanagersholdsuperiorinf ormation,thestockpricewould fallwhentheyarereleasedtofina nceinvestment
- Theconsolidationofcompanies withlowandhighcashholdingsw ouldincreasethecompany’scombi nedvalue
T h e companywithhighdebtleve lswillemitasignaltoinvestorsthat thefuturecashflowsofthecompa nyarehighquality.Ifacompanyisr eq u i r ed toissuenewequity,that wouldbeanegativesignaltoinves tors.
- Threest ageleastsq uaresregr essionmo del(3SLS )
- Cross- sectionalsample:10 14ex ch an ge listed non- financialfirmsfro m18emering marketsin1995- 1996
- Debtlessenedthereductioninfir mvaluethatfollowaseparationbet weenamanagementgroup’sco ntrolrightsanditsproportionalca shflowownership
-Theinternationalloansearnpositi vecumulativeaberrantreturns.Th esecumulativeaberrantreturnsare positive non- financialfirmsfrom 20emeringmarketsin theperiodof1980- 1997
- Ownershipissuingsa mple:252firms affectedontheseparationofcontro landownership.Thispositiverela tionisfocusedonfirmswithahighle velofassetsorlessgrowthopportuni ties
- Initialissuesofpublicinternational bondsledtosignificant aberrantr eturns,butthesereturnsarenotmatc hedwithmanagementownershipst ructures
- Thesampleof58 ,053firm- yearobservation sduringtheperio dof1988-2002.
- Thesampleof15 70firm- yearobservations duringtheperiod of1988-1995.
- Freecashflowincreasedsalesand salesenhancedfirmperformancein casethecompanieshadthelowleve loff r e e cashflow
Usingannua lizedregress ionsfollowin gtheapproach ofFamaand Macbet(197 3)
- Stockpricesactasifinvestorsanti cipatetheconstantofearningsfro mdebtandequity,butoverestimate theconstantofearningsthatisreta inedcashbalance
- Ifthecompanieshadalargeposi tivefreecashflow,theywouldsp endalmostofittofutureinvestm entprojectsw h i c h gainedthelow ermarginalbenefitandtherefore,w o ul d reducethevalueofthe companies
Unrelateddiversificationgavecom panyadiscountbutrelateddiver s ification broughttocompanya premium.
- Companyneedtocreatetheba rrierstoimitationbycompeti torstoensurethesustainability ofcompetitivead vantage
- Therewerefourstepstoimprov ethefirmperformancethroughef ficientrelateddiver sifi catio n
659firmswith 16,181 observations,ofwhi ch5,233aremulti- segmentintheperio dof1986-
- Thediversificationdestroyedthefi rmvalueinalltimeandanysizeoffi rmwhichcanbeexplainbyover- investmentandcross- subsidization
- Apositivesignificanteffectofrel ateddiversificationonfirmvalueh asfoundoutwhichcanbeexplainby theco-insuranceeffect financialservices.
Asampleof48,773fir ms- yearo bserv at i ons which11,831observa tionsfromdiversifiedfi rmsintheperiodof19 90-
- Leveragereducedthevalueinthe non- diversificationcompaniesbuthadthe positiveeffect onvalueofdiversif iedcompanies
Asampleof308res taurantcompani esinthep erio d of 1995-
- Leveragehasthepositiveeffect onfirmperformance,butfirmperfo rmancehasnoimpactonleveragedi rectly.Itnegativeeffect onunrelat eddiversificationwhichpositive effect onleverage
- Thefreecashflowincreasediver sificationinbothtwotypes.Andi tderectlydestroyedfirmperforman ce.Anegativeeffectofleverageo nfreecashflowwasalsofound.
- Relateddiversificationhadapos itiveeffectonfirmperformance,buttherelationshipbetweenunr elateddiversificationandfirm performanceisnegative.Debtlev eragecandecreasetherelateddi versificationandunrelateddivers ificationhaspositiveeffectedonl everage
Tax shield and cost of bankruptcy
Agency cost Prevent over - investment
Diver- sification Managers compensation Perfor- mance FCF
Aholisticframework
Fingure2.1:Summaryofseparateresearchrelatedtocapitalstructure,freecashf l o w , di versificationandfirmperformance
Figure2.1:Holisticframeworkforcapitalstructure,freecashflow,diversificationandfirmp erformance
Model
Thes t u d y a d o p t e d t h e m o d e l o f t h e P a r k a n d J a n g ( 2 0 1 3 ) t o c l a r i f y t h e r e l a t i o n s h i p b e t w e e n thefourfactors:capitalstructure,freecashflow,firmdivers ificationandfirmperformance.T h e d e p e n d e n t v a r i a b l e s a r e u s e d i n t h e r e s e a r c h a r e Tobin’sq ( r e p r e s e n t i n g firmperformance),FCF(representingfre ecashflow),R_entropy(relateddiversification), U_entropy(unrelateddiversifica tion)andfinallyln(TDL)
(representingt h e company'scapitalstructure).Theempiricalmodelsare usedtotesttheinter–r elat ionships betweenthefourfactorsareasfollows: ln(Tobin’sq) i,t =α+β 1 xFCF i,t +β 2 xR_entropy i,t +β 3 x U_entropy i,t +β 4 x ln(TDL) i,t +β 5 xCashflow i,t +β 6 xSales_GR i,t +β 7 xln(sales) i,t +∑DY t +ε i,t (1) FCF i,t
=α+β 1 xln(TDL) i,t +β 2 xequity_repurchase i,t +β 3 xdummy_Dividend i,t +β 4 xln(sa les) i,t +∑DY t +ε i,t (2)
=α+β 1 xFCF i,t +β 2 xln(Tobin’sq) i,t +β 3 xln(TDL) i,t +β 4 xRER i,t +β 5 xPPNE i,t +β
6 xln(Ad_Ex) i,t +β 7 xln(sales) i,t +∑DY t +ε i,t (3)
U_entropy i,t =α+β 1 xFCF i,t +β 2 xln(Tobin’sq) i,t +β 3 xln(TDL) i,t +β 4 xRER i,t +β 5 xPPNE i,t +β 6 x ln(sales) i,t +∑DY t +ε i,t (4) ln(TDL) i,t =α+β 1 xR_entropy i,t +β 2 xU_entropy i,t +β 3 xln(Tobin’sq) i,t +β 4 xQR i,t
+β 5 xWcap i,t +β 6 xln(Capx) i,t +β 7 xln(sales) i,t +∑DY t +ε i,t (5)
Variable Decription ln(Tobin’sq)it NaturallogarithmictransformedTobin’sqoffirmiatyeart
Unrelatedentropyoffirmiatyeart ln(TDL)it Naturallogarithmicoftotaldebtleverageforfirmiatyeart
Sales_GRit Netsalegrowthoffirmiatyeart ln(Sales)it
TheratioofequityrepurchasetototalassetsforfirmiatyeartD u m m y _ D i v i d e n d it The firm’sdividenddummyvariablewhichhasvalueone iffirmi atyeartpaidoutthedividendandequalszeroiffirmdidnotpaythedi vidend
PPNEit Naturallogarithmicratiooffixedassetstototalassetsforfirmiatyeart ln(Ad_Ex)it Naturallogarithmicofadvertisingexpenditureforfirmiatyeart
Quickr a t i o w h i c h i s d e f i n e d t h e r a t i o b e t w e e n q u i c k a s s e t s a n d currentliabilities.Itrefectstheabilityo f firmto payo u t thecurr ent l i a b i l i t i e s byt h e q u i c k a s s e t s , n o t u s i n g i n v e n t o r y I t iscalculatedbysumo f c a s h a n d s h o r t - t e r m investmenta n d t o t a l r e c e i v a b l e overtotalcurrentliability Wcapit Workingcapitaloffirmiatyeart ln(Capx)
Variabledecription
Tobin’sq
Tobin's q is a key indicator of firm performance, reflecting the market value of a company relative to its book value A higher Tobin's q signifies that the market values the company more than its recorded assets As defined by Himmelberg et al (1999) and Park and Jang (2013), Tobin's q is calculated by dividing the market value of the company, which includes common equity and total liabilities, by the replacement value of its assets, determined by the book value of total assets However, many Vietnamese companies do not disclose information about preferred stock, making data collection on this aspect challenging Additionally, most Vietnamese firms primarily raise equity through common stock, rendering preferred stock an insignificant component Consequently, when calculating Tobin's q, the value of preferred stock can be disregarded.
Freecashflow
Richardson’s( 2 0 0 6 ) g a v e t h e f o r m u l a t o e s t i m a t e t h e f r e e c a s h f l o w F r e e c a s h f l o w v a r i a b l e w a s a l s o c a l c u l a t e d byParka n d J a n g ( 2 0 1 3 ) b a s e d o n t h e met hodo f Richardson's(2006).Accordingtothesestudies,thefreecashflowiscalcul atedasn e t cash f l o w f r o m o p e r a t i o n minust h e c o s t ofmaintainingi n v e s t m e n t a n d p l u s R & D expenditure(tobereplacedbytheadvertisingexpenditureinth epaperoftheParkandJang,2013).
In Vietnam, the investments required to maintain existing assets, advertising expenses, and anticipated investments in new projects are often not accurately reflected in companies' financial statements Even when such data is available, it is frequently unreliable, as companies tend to keep their business strategies confidential Increased advertising spending or new project investments can attract competitors' attention, prompting them to develop similar projects to compete with the company's offerings To align with the existing data in Vietnam, free cash flow is calculated as net revenue plus depreciation, minus changes in working capital and capital expenditures.
Depreciationispresentedinthecashflowstatement(#2)forthecompanyappliesindirectd e p r e c i a t i o n method.Forcompaniesthatusedirectdepreciationmethod,depreciationisc a l c u l a t e d bythetotalchangeinvalueofaccumulateddepreciationbetweenyeartandt-1.
Capitale x p e n d i t u r e i s c a l c u l a t e d a s t h e t o t a l c h a n g e i n f i x e d a s s e t s a n d c h a n g e s ind ep reci at io n betweenyeartandt-1.
Relatedentropyandunrelatedentropy
The degree of firm diversification is first measured by Jacquemin and Beery (1979) using entropy diversification, which categorizes a firm's revenue into three main sources: core business, related business, and unrelated business There remains considerable debate regarding the valuation of related and unrelated sales Rumelt's classification identifies related diversification as businesses sharing the same first two digits of SIC codes with the firm's core business, while unrelated diversification consists of businesses with differing first two digits However, Porter (1987) and Teece (1982) argue that related diversification allows the parent company to leverage coordination between related and core businesses to gain competitive advantages This synergy enables related diversification and core business to share core assets and competencies Park and Jang (2013) also utilized this definition in their study to assess related and unrelated entropy within restaurant firms.
Where: DRis the relatedentropy AhigherDR meansthatfirm ish i g h l y diversifiedintorelatedbusiness
Pjistheratioofthefirm’stotalsaleswithinthej th industry group
Where: DUistheunrelatedentropy.AhigherDUmeansthatfirmishighly diversifiedintounrelatedbusinessM ist henumberofindustrygroups
Saleso f eachb u s i n e s s o r s e c t o r , i n d u s t r y g r o u p s a r e p r e s e n t e d int h e n o t e s t o thefinan cial statementsofcompany,therevenueandsegmentreportingitem.
Totaldebtleverage
Totaldebtleverageoccurswhenacompanyusesfinancialleverageandoperationleverageat the sametimetotrytoincreaseincome of shareholders.Acompany usingt o t a l debtlever agecansignificantlymagnifytheincrease(ordecrease)inrevenueincrease(ordecrease)inearn ingspershareofshareholders.
Thec a s h f l o w o f a c o m p a n y isd e f i n e d byP a r k a n d J a n g ( 2 0 1 3 ) a s e a r n i n g s b e f o r e d e p r e ci a t i o n m i n u s t axesa nd g r o s s in te res tex pe nse a n d d i v i d e n d p a y m e n t s (i nc lu di ng paymentofdividendstocommonstockandpreferencestock)dividedby totalassets.Tos i m p l i f y t h e c a l c u l a t i o n s , t h e c a s h f l o w v a r i a b l e i s c a l c u l a t e d fromt h e i n c o m e a f t e r payingt a x , i n t e r e s t a n d d i v i d e n d s p l u s d e p r e c i a t i o n a n d d i v i d e d byt o t a l assets.T h e formulatocalculatethecashflowis:
Advertising expenditure
According to Park and Jang (2013), advertising expenditure is a crucial factor in determining free cash flow and plays a vital role in differentiating between related and unrelated entropy However, the public nature of advertising expenditure can expose a company's investment and sales strategies to competitors, leading to its rare appearance on the financial statements of Vietnamese companies Additionally, advertising expenditure can be viewed as an investment portfolio, and taking the logarithm of this expenditure provides insights into corporate investment levels To align with Vietnam's business environment, the natural logarithm of advertising expenditure will be substituted with the ratio of capital expenditure to revenue (Capex/Sales).
Workingcapital
Data
Thed a t a u s e d t o a n a l y z e t h e r e l a t i o n s h i p b e t w e e n c a p i t a l s t r u c t u r e , c a s h f l o w , d i v e r s i f i c a t i o n andfirmperformanceiscollectedfromtheannualauditedfinancia lr e p o r t s by1 1 8 c o m p a n i e s o n Hanois t o c k exchanges (HNX)andHochiminhstocke x c h a n g e ( H O S E ) , i n c l u d e d 8 7 d i v e r s i f i c a t i o n c o m p a n i e s T h e s e c o m p a n i e s s h o u l d b e satisfiedwiththefollowingconditions:co mpaniesarelistedontheStockExchangebyt hee n d o f 2 0 1 4 T h e r e a r e n o b i g c h a n g e s d u r i n g t h e c o m p a n y ’ s f i n a n c i a l yearo r operation ofbusinessesi nresearchperiod;itmeansthatcompanydidnottransformtheir
31 35 businessformo r b a n k r u p t c y I n a d d i t i o n , d a t a o n t h e f i n a n c i a l statementso f c h o o s e companiesm u s t b e c o m p l e t e w i t h t h e v a r i a b l e s i n t h e model.T h e s t u d y a l s o e x c l u d e companiesfromthefinancialsectorsuchasbanking,insurance,securitiesb ecausethesecompaniesreportfinancialstatements underaspecialaccountingstandards,with specificc h a r a c t e r i s t i c s Sampledataisobservedduringtheperiodfrom2009to20 14,total708firm- yearobservations.Financialstatementsandfinancialindicatorsofthecompaniesaretakenfromthesto ckdatapagesVietstock,CafeF,StockBizandcorporate’swebsites.
Variable N Mean Std.Dev Min Max
This table provides descriptive statistics for the model variables, including the natural logarithm of Tobin's q (Ln(Tobin's q)), which reflects market valuation Free cash flow (FCF) is normalized by the previous year's total assets, while R_entropy and U_entropy measure related and unrelated diversification, respectively The natural logarithm of leverage is represented as ln(TDL), and cash flow is also normalized by prior year's total assets Sales growth rate (Sales_GR) indicates net revenue growth, and the natural logarithm of sales is denoted as ln(Sales) Equity repurchase is expressed as the ratio of common and preferred stock purchases to total assets, with Dummy_Dividend indicating if dividends are paid in a given year The ratio of retained earnings to total assets is represented as RER, and PPN_E is the natural logarithm of the ratio of fixed assets to total assets Additionally, ln(Ad_Ex) represents the natural logarithm of advertising expenditure, calculated as the ratio of capital expenditure to sales (Capex/Sales) Finally, QR is the ratio of total cash, short-term investments, and accounts receivable to total current liabilities, while ln(Capx) denotes the natural logarithm of capital expenditures.
Table3.3:SpearmanandPearsoncorrelation lnQ FCF DR DU lnD CF SGr lnS Re Div RER PP lnA QR Wca lnC lnQ 0.18 0.13 -0.07 -0.12 0.57 0.16 0.18 0.02 0.18 0.47 0.04 0.02 0.15 0.12 0.10
(Thistabledisplaysthecorrelationbetweenthevariablesinthemodel.ThecorrelationincludesSpearmancoefficient(theu p p e r diagonal)andPearsoncoefficients(thebelowthediagonal))
Table3.3presentstheSpearmancorrelationandPearsoncorrelationamongthevariablesi n the model.Pearsoncorrelationmeasuresthedegreeoflinearcorrelationbetweentwov a r i a b l e s
Thiscorrelation wasmadefirstbyGalton(1888)bydividing thecovarianceoft wo variableswiththemultiplicationoftheirstandarddeviation.Pea rsoncorrelation(r)hasvaluefrom-
1to+1,showsdemonstrationaboutrelationshipbetweentwovariables.Thehigherabsol utevalueofristhegreatercorrelationbetweentwovariablesordataismores u i t a b l e f o r l i n e a r c o r r e l a t i o n F o r e x a m p l e , t h e c o r r e l a t i o n betweenF C F a n d ln(Tobin'sq ) is0 1 9 , i n d i c a t i n g t h a t t h e s e t w o v a r i a b l e s a r e p o s i t i v e l y correl atedw i t h e a c h other.WhenFCFincreases,ln(Tobin'sq)willalsobeexpectedtoincreasean dvicever sa O n t h e o t h e r h a n d , t h e r e i s a n e g a t i v e c o r r e l a t i o n b e t w e e n l n ( T o b i n ' s q ) a n d ln(TDL)(-
0.23).Meanwhile,anincreaseinthevalueofln(Tobin'sq)willcausethevalueo f ln(TDL)decreas es.However,ifthecorrelationbetweentwoindependentvariablesinthemodeli s veryl a r g e ( a b s o l u t e v a l u e g r e a t e r than0 8 ) , i t w i l l e a s i l y l e a d t o t h e multicollinearity.Thesewillbetested furtherintheestimationresultsofthemodel.
Inaddition,totesttherelationship between tworanked variables,orbetweenaran kedvariableandameasurementvariable,andtopreventtwovariablesdonotfollownorm ald i s t r i b u t i o n , thestudyalsouseSpearmanrankcorrelation.Theresultsintable3.3sh ownos i g n i f i c a n t d i f f e r e n c e s b e t w e e n t h e marksa n d t h e v a l u e b e t w e e n t h e t w o t y p e s o f correlation.
Methodology
Simultaneousequations
An independent variable that is not correlated with the error term is known as an exogenous variable, which influences a model without being affected by it In contrast, an endogenous variable is correlated with the error term, leading to potential biases in regression analysis Classical linear regression models assume that independent variables are not correlated with the error term, indicating the absence of endogenous variables However, various models recognize the interaction between independent variables and the error term Three primary threats to endogeneity include omitted variable bias, measurement error in independent variables, and simultaneity Omitted variable bias occurs when a relevant variable is excluded, creating a correlation between the independent variable and the error term Measurement error can also induce correlation, while simultaneity arises when changes in independent variables affect the dependent variable and vice versa, resulting in endogenous explanatory variables In such cases, traditional regression models fail to accurately explain the data, necessitating the use of simultaneous equations regression models Using OLS, FGLS, SUR, or ISUR estimators in the presence of simultaneous issues can yield biased and inconsistent estimates Alternative approaches for estimating simultaneous equations include single-equation methods like 2SLS and system methods such as 3SLS.
Two-Stage Least Squares (2SLS)estimator
S t a g e L e a s t S q u a r e s e s t i m a t o r i s a specialtypeofInsrument variables(IV)esti mator 2SLSmethodallowsestimating theparametersmoreefficientbecausethestep sofestimationofthismethodwillmaketheequationsbecometheexogenousequations.Iti ncludestwofollowingapplicationsoftheO L S e s t i m a t o r , t h e r e a r e t w o s t a g e s p r o c e d u r e w h i c h 2 S L S s o l v e s t h e e n d o g e n i o u s problem:
Stage1:estimatingthereducedform equation.Reducedform equationisanequationforw h i c h allexplainatiryvariablesareexogenous.Regresseachright- handsideendogenousv a r i a b l e intheequationtobeestimatedonallexogenousvariab lesinthesimultaneouse q u a t i o n modelu s i n g t h e O L S e s t i m a t o r C a l c u l a t e t h e f i t t e d v a l u e s f o r e a c h o f t h e s e endogenousvariables.
Stage2:Intheequationtobeestimated,replaceeachendogenousright- handsidev a r i a b l e byitsfittedvaluevariable.EstimatetheequationusingtheOLSestimato r.Theestimateds t a n d a r d e r r o r s a r e a c q u i r e d f r o m t h e s t a g e 2 a r e n o t c o r r e c t a n d m u s t b e c o r r e c t e d S t a t i s t i c a l programst h a t h a v e a 2 S L S p r o c e d u r e m a k e t h i s c o r r e c t i o n a u t o m a t i c al l y andreportthecorrectstandarderrors.
The2SLSestimatorhasalotofadvantagesinestimatingsimultaneousequations.Itcanb e appliedtoeachequationseparately,withoutpayingattentiontotheotherequations.
T h i s isadvantageouswhenestimatingamultiequation.Itiseasytoapplybecauseitjustr e q u i r e d theeconomistsidentifythetotalnumberofexogenousvariablesanddetermindthe instrumentvariablesfortheseexogenousvariables.However,2SLSestimatorisonlya p p l i e d incaselargesample.
Three–StageLeastSquares(3SLS)
StageLeastSquares orsystemmethodisaestimatorwhichisanextensionof2SL Sandus ed toestimate theequations ofa systemequation T h e estimatesreceivedf r o m 3 S L S arebiasedestimator,asymptotic efficiencyb u t consistent.Thismethodconsistsofthefollowingthreestages:
Calculatet h e residuale1t,e2t,…,emtobtained instage2 corresponding to thestructuralequations.
Calculate the covariance matrix of random errors for each equationsystem.
Hausmenttest
In this research, the choice between 2SLS and 3SLS estimators is critically examined using the Hausman specification test This test evaluates the consistency of each estimator for the equations in the system by comparing the Wald statistics of both methods The null hypothesis posits that the difference in coefficients is not systematic; if it cannot be rejected, the 3SLS estimator is deemed consistent and efficient, while 2SLS is only consistent Conversely, if the null hypothesis is rejected, the coefficients from 3SLS are inconsistent, whereas 2SLS remains consistent Ultimately, the study estimates five equations using both 2SLS and 3SLS methods, applying Hausman's specification tests to inform the selection between these estimation techniques.
Resultsexpectation
Effectoffreecashflow,diversificationandleverageonfirmperformance
cashflow,diversificationandleverageonfirmperformanceln(Tobin’sq) i,t =α+β 1 xFCF i,t + β 2 xR_entropy i,t +β 3 x U_entropy i,t + β 4 x ln(TDL) i,t + β 5 xCashflow i,t +β 6 xSales_GR i,t +β 7 xln(sales) i,t +∑DY t +ε i,t (1)
Based on previous studies, the coefficient β1 of Free Cash Flow (FCF) is anticipated to become negative in the regression model, aligning with earlier findings.
P ar ka nd J a n g (2013)whosuggestedthatthecompanieswithlargefreecashflowtendstoinvestin n eg at i v e p r o j e c t s t h a t d a m a g e s thefirmp e r f o r m a n c e T h e c o e f f i c i e n t o f R _ e n t r o p y i s expectedp o s i t i v e s i g n i f i c a n t l y , s u g g e s t i n g t h a t i n v e s t i n g inr e l a t e d b u s i n e s s a r e a s w i l l increasethecompanyvalue.Incontrast,thecoefficiantofU_entr opyisexpectedn e g a t i v e , meansthatinvestinginastrangebusinesswilldecreasethef irmperformance.T h i s isconsistentwiththestudybyParkandJang(2013).
Debtleverageisexpectedn e g a t i v e r e l a t i o n s h i p w i t h firmp e r f o r m a n c e , b e c a u s e accordingtothesignaleffectofRoss(1997),onlythehigh-qualitycompaniescanhandle larged e b t s w i t h o u t l e a d t h e p o s s i b i l i t y o f bankruptcy.B e s i d e s , t h e a g e n c y t h e o r y o f J e n s e n andMeck li ng (1 96 7) andJ e n s e n ( 19 86 ) alsoagreedth at betw eenle ver agea nd f i r m performancehaveapositiverelationship.ParkandJang(2013)intheirstudyalsof o u n d evidenceoftherelationshipbetweentwovariables.
Effectofleveragetofreecashflowofthecompany
=α+β 1 xln(TDL) i,t +β 2 xequity_repurchase i,t +β 3 xdummy_Dividend i,t +β 4 xln(sa les) i,t +∑DY t +ε i,t (2)
Int h i s e q u a t i o n , l n ( T D L ) i s a v a r i a b l e s h o u l d b e mostc o n c e r n e d a b o u t A n e g a t i v e r el a t io n s h i p isexpectedtooccurbetweenln(TDL)andFCFbecauseofa gencyproblem.A c c o r d i n g tothestudyofBushetal.(2000),Fairfieldetal.(2003),Dechowetal.(2008),and ParkandJang(2013),agencyproblemcanbemitigatedthroughacapitals tructured e c i s i o n byincreasingdebt.
Effectoffreecashflow,companyperformanceandleveragetothed i v e r s i f i c a t i o n oft hecompany
=α+β 1 xFCF i,t +β 2 xln(Tobin’sq) i,t +β 3 xln(TDL) i,t +β 4 xRER i,t +β 5 xPPNE i,t +β
6 xln(Ad_Ex) i,t +β 7 xln(sales) i,t +∑DY t +ε i,t (3)
U_entropy i,t =α+β 1 xFCF i,t + β 2 xln(Tobin’sq) i,t + β 3 xln(TDL) i,t + β 4 xRER i,t + β 5 xPPNE i,t +β 6 x ln(sales) i,t +∑DY t +ε i,t (4)
Theresearchwilltesttherelationshipbetweenthesediversificationfactorsthrought woequationsofrelateddiversificationandunrelateddiversification.AsaresultofParkan dJang (2013),FCFinbothequations isexpectedto bringapositivesign,indicati ngthec o m p a n y withbi gf re e c as h f lo wt en ds t o d iv ers if y throughone of t w o d i v e r s i f i c a t i o n strategy.T h e c o e f f i c i e n t o f l n ( T D L ) i s a l s o e x p e c t e d t o b e c o m e n e g a t i v e b e c a u s e a c c o r d i n g toagencytheorydebtleveragecan reducethelevelofunrelateddiversificationi n company.
Effectof diversificationand companyperformancetoleverage
ln(TDL) i,t =α+β 1 xR_entropy i,t +β 2 xU_entropy i,t +β 3 xln(Tobin’sq) i,t +β 4 xQR i,t
+β 5 xWcap i,t +β 6 xln(Capx) i,t +β 7 xln(sales) i,t +∑DY t +ε i,t (5)
Inthisequation,thecoefficientβ1i sexpectedtobecomenegative,whilethecoefficientβ 2 i s expectedtobringapositivesign,becauseinthetransactioncoststheoryo f MarkidesandWilli amson(1996),participatedinrelateddiversificationwillreducedebtleverage,butthefield isunrelateddiversificationwillincreasedebtleverage.Sothereist h e opposition’sexpec tationforthesetwovariables.ln(Tobin'sq)intheresultsofParkandJang(2013)don othave acleareffectondebtleverage,socoefficients β3canbee x p e c t e d tobeco menegativeorpositivedependingonVietnamesefirm’sdata.
Effectoffreecashflow,diversificationandleveragetocompanyperformance 504 2 Effect
Dep.Var:ln(Tobin’sq) OLS 2SLS 3SLS
The dataset analyzed non-financial companies from 2009 to 2014, focusing on key variables such as the natural logarithm of Tobin's q (ln(Tobin’s q)), which measures firm value Free cash flow (FCF) was normalized by prior year's total assets, while R_entropy and U_entropy quantified the degrees of related and unrelated diversification, respectively Additionally, the natural logarithm of leverage (ln(TDL)) was examined alongside cash flow, which was also normalized by prior year's total assets The study further included the net revenue growth rate (Sales_GR) and the natural logarithm of sales (ln(Sales)).
Table 4.1 presents the results of a regression analysis examining the impacts of free cash flow, diversification, and capital structure on firm performance using OLS, 2SLS, and 3SLS methods The Hausman specification test indicates that the null hypothesis is not rejected, suggesting that the 3SLS estimator is more consistent and efficient than the 2SLS estimator Consequently, the analysis and conclusions regarding the effects of free cash flow, diversification, and capital structure on firm performance will rely on the 3SLS estimator While the coefficient of free cash flow is not significant in the OLS and 2SLS models, it is negative and marginally significant in the 3SLS model.
The findings indicate a significant relationship (0.207 with a 10% significance level) consistent with agency costs theory as proposed by Jensen (1986) and Jensen and Meckling (1976) This theory posits that excessive financial resources can lead to substantial free cash flow within a company, prompting managers to invest in inefficient projects, even those with negative Net Present Value (NPV), to pursue personal objectives at the expense of shareholder interests—a phenomenon known as over-investment Managers may engage in over-investment of free cash flow to enhance their compensation and secure their positions within the company (Rose and Shepard, 1997; Denis et al., 1997) Consequently, such over-investment can lead to a decline in company value, a conclusion that is further supported by various studies examining the relationship between free cash flow and firm performance, as highlighted by Titman et al.
Aboutd i v e r s i f i c a t i o n v a r i a b l e s , b o t h r e l a t e d a n d u n r e l a t e d d i v e r s i f i c a t i o n inO L S a n d 2SLSmodelwere nots i g n i f i c a n t, ietheydon ot haveanimpactonf i r m performance.However,the3SLSmodelgaveasimilarresultwhenshownthatrelate ddiversificationa n d unrelateddiversificationinfluenceonfirmperformance.Coeffi cientofrelatedd i v e r si f i c at i o n is-1.731with asignificancelevelof5%andunrelateddiversificationalsoh a s a n e g a t i v e r e l a t i o n s h i p w i t h firmpe r f o r m a n c e ( -
The study reveals a diversification discount of 2.529 at a significance level of 5%, suggesting that diversification strategies can negatively impact firm value Managers often pursue diversification to enhance their compensation and job security, particularly in scenarios with limited investment opportunities While diversification can drive sales growth and expand product markets, it also introduces greater risks and initial costs, potentially leading to reduced firm performance and declining stock prices In the context of Vietnam, companies are diversifying to enhance revenue and competitive advantage, but unrelated diversification poses significant risks Additionally, the cross-subsidization effect may contribute to the diversification discount, as companies offset losses in one segment with profits from another for tax benefits These findings align with previous research by Berger and Ofek (1995), Comment and Jarrell (1995), Stulz (1990), Lang and Stulz (1994), and Finkelstein and Hambrick.
Resultsfromtable4.1showsthattheleveragehasnoimpactonfirmperformance.Thissee msstrangebecausepreviousstudieshaveconcludedthatleveragerelationshipswit hf i r m performance.However,consideringVietnammarketinrecentyears,thiscouldstill h a p p e n A f t e r alongperiodoffinancialcrisisandpublic– debtcrisisinEurope,companiesa r e l i m i t e d tob o r r o w debt becauset h e u n c e r t a i n t y ofthemarket.Mostcompaniesareoperatingbasedontheavailablefunds,s othedebtratiowillnofluctuatew i t h i n thecompany.Therefore,thedebtleveragedoesnotaffec tfirmperformance.
Dep.Var:FCF OLS 2SLS 3SLS ln(TDL) -0.09***(-8.53) -0.181***(-5.11) -0.181***(-5.64)
(Thesampleincludeddataofnon- financialcompaniesfrom2009to2014.ThedependentvariableFCFisthefreecashflowwasnomal izedbyprioryear’stotalassets;ln(TDL)ist h e naturallogarithmofleverage;Equity_Repurchasei stheratioofpurchaseofcommona ndpreferredstocktototalassets;Dummy_Divideneisthedu mmyvariablewhichequalo n eifthecompanypaysdividendintheyear;ln(Sales)isthenatura llogarithmofsales.
Table4.2providedevidenceoftherelationshipbetweencapitalstructureandfreec ashf l o w o f t h e company.TheHausmans p e c i f i c a t i o n t e s t i s n o s i g n i f i c a n t , s o t h e n u l l hypothesisisnotrejected.Therefor,Hausmantestsuggeststhat3SLSisbettertha n2SLSi n thisequation.Both modelsshow thenegativeeffectsofdebtleveragetofreecashflow.T hese impactsaresignificantatahighlevel.ThisresultisconsistentwiththefindingsofLangetal.(1996)Fairfieldetal.
Excess financial resources often lead to significant positive free cash flow in companies, which can result in managers misallocating these funds into over-investment projects that ultimately harm corporate value To mitigate this risk, investors seek to control free cash flow, and utilizing debt serves as an effective strategy for enhancing management oversight By imposing interest payment obligations, debt compels companies to reduce cash holdings, thereby limiting free cash flow and preventing managerial waste Consequently, this approach can significantly improve firm performance, as a well-managed debt ratio ensures that companies maintain minimal cash reserves after covering interest expenses.
Effectoffreecashflow,companyperformanceandleveragetothediversificationo f thecompa
Dep.Var:R_entropy OLS 2SLS 3SLS
The study analyzes data from non-financial companies between 2009 and 2014, focusing on the dependent variable R_entropy, which measures the degree of related diversification Key variables include ln(Tobin's q), representing the natural logarithm of Tobin's q, and FCF, which is the free cash flow normalized by the previous year's total assets Additional metrics include ln(TDL), the natural logarithm of average total debt liabilities, RER, the ratio of retained earnings to total assets, and PPNE, the natural logarithm of the ratio of fixed assets to total assets Advertising expenditure is represented as ln(Ad_Ex), calculated by replacing it with the ratio of capital expenditure to sales (Capex/Sales), while ln(Sales) denotes the natural logarithm of net revenue The significance levels are noted at 1%, 5%, and 10%, though coefficients for year dummies and standard errors are not reported in detail.
Dep.Var:U_entropy OLS 2SLS 3SLS
(Thesampleincludeddataofnon- financialcompaniesfrom2009to2014.ThedependentvariableU_entropyisthe degreeofunrelateddiversification;ln(Tobin'sq)isthe naturallogarithmofqofTobin;FCFisthefreecashflowwasnomalizedbyprioryear’stotalasset s;ln( T D L ) i s t h e n a t u r a l l o g a r i t h m ofl e v e r a g e ; R E R i s ther a t i o o f r e t a i n e d earningstototalassets;PPNEisthenaturallogarithmoftheratiobetweenfixedass etsa n d totalassets;ln(Ad_Ex) isthenaturallogarithmoftheadvertisingexpenditurewhichreplacedbytheratioofcapitalexpe ndituretosalesCapex/
Sales;ln(Sales)isthenaturallogarithmofnetrevenue.* , * *, * * * s i g n i f i c a n t l ev e l at1%,5
Table4.3and4.4showtheresultsofregressionequationsdiversificationentropyincludin gr e l a t e d a n d u n r e l a t e d d i v e r s i f i c a t i o n T h e H a u s m a n s p e c i f i c a t i o n t e s t i s n o si gn if i cant , sothenullhypothesisisnotrejected.Therefor,Hausmant estdemonstratest h a t 3 S L S ismoree f f i c i c e n t a n d c o n s i s t e n t t h a n 2 S L S R e s u l t s f r o m b o t h t w o tables
57 fingero u t a n e g a t i v e i m p a c t o f f r e e c a s h f l o w o n b o t h r e l a t e d a n d u n r e l a t e d diversification.However,whilethisrelationshipisreallyclearintherelatedd i v e r s i f i c a t i o n entropyequation,itisnosignificantintheunrelateddiversificatione n t r o p y equa tion.ThiscontrastswiththeresultsoftheParkandJang(2013)whenthea u t h o r s pr esentedevidenceofapositiverelationshipbetweencashflowanddiversification,meani ngt h a t w he n t h e c o m p a n y appearsa n e x c e s s f r e e c a s h f lo w, t h e managerstendtop articipateindiversificationthroughoneorbothrelatedandunrelatedd i v e r s i f i c a t i o n strategies.However,withthedatafromVietnamesecompanies,thecashflowcoeffic ientisnegativeandsignificant(-
At a significance level of 1%, the analysis indicates that deteriorating free cash flow prompts companies to seek new investment opportunities to boost revenue Typically, firms prefer to engage in related businesses rather than unrelated ones when facing decreased free cash flow This behavior can be attributed to the desire to minimize risks associated with unfamiliar industries, where initial costs and risks can be substantial Companies are advised against pursuing diversification when free cash flow is negative, as this could exacerbate financial instability Conversely, when companies experience positive cash flow, they are more likely to invest in existing assets to mitigate financial distress rather than diversify their operations.
( 2 0 0 3 ) s h o w e d t h a t b e t w e e n d i v e r s i f i c a t i o n a n d f i r m performancehasanendo genousrelationship.Resultsfromtwoabovetablesalsosupportt h e s e c o n c l u s i o n s T h e c o e f f i c i e n t s o f f i r m performancef r o m u n r e l a t e d d i v e r s i f i c a t i o n e n t r o p y equa
58 tionsaresignificant(-0.138at5%significance level).Thisimpliesthat poorperformancecompaniestendtoinvestinotherindustrieslessrelevanttothecoreb u s i n e s s ofthecompany,thegoalforthisdiversifiesactivitycanbetogetovercomethedifficults ituationinitsindustry.Conversely,thegreatperformancecompanieswillwisht o focusmore onthecorebusinessofthem,whichbringthemhugeprofits.Thesefirms willp r e f e r t o i n v e s t int h e maintenanceo f t h e c u r r e n t a s s e t s i n p l a c e a n d t h e c u r r e n t b u s i n e s s a c t i v i t i e s o f companies,i n v e s t m e n t i n r e s e a r c h a n d d e v e l o p m e n t o f p r o d u c t s w h i c h hasbeenthestrengthoftheirtofurtherimproveefficiency.Resultsf romtable4.3and4.4consistwiththefindingsandexplainationoftheHall(1995),Rijamamp ianinaetal.(2003)andParkandJang(2013).
Finally,t h e r e s e a r c h considerst h e i m p a c t o f l e v e r a g e o n t h e i m p l e me n t a t i o n o f d i v e r s i f i c a t i o n Coefficientsofleverageinbothequationsarenegativebutjustsignigicanti n u n r e l a t e d d i v e r s i f i c a t i o n e n t r o p y eq ua ti on ( -
0 0 4 5 w i t h 1 % s i g n i f i c a n t l e v e l ) Theser e s u l t s areconsistentwithapartofconclus ionofParkandJang(2013)whichsuggestedthatdebtleveragehasasignificantnegativeimp actonrelateddiversificationbutwithoutaffectingu n r e l a t e d d i v e r s i f i c a t i o n T h e s e c o e f f i c i e n t s c a n b e e x p l a i n e d byt h e agencyc o s t s AccordingtoJensenandMec kling(1976)andJensen(1986),theincreaseindebtleveragewillreducediversificationthrou ghfr ee cashflow.T h e companieswithalow d e b t r a t i o c o u l d l e a d t o f i n a n c i a l e x c e s s e s a n d so,o v e r i n v e s t m e n t ( L i a n d L i , 1 9 9 6 ) T h e r e f o r e , ifcompanieswant toavoidnegativeimpactofdiversificationonperformance,t h e y needtomaintainareasonabledeb tratio.Inunrelateddiversificationcompanies,debtisprovedtobeaneffectivetooltoreduceage ncycosts.Thus,thesecompaniesneedtomaintaina h i g h e r debtr a t i o t h a n n o n - d i v e r s i f i e d companiesi n o r d e r t o a v o i d o v e r - investment( R i a h i -
B e l k a o u i a n d B a n n i s t e r , 1 9 9 4 ) H o w e v e r , t h e r e l a t i o n s h i p b e t w e e n r e l a t e d diversificationandleverageisnotapparent,itimpliesthattheinvestorsdonotseeleverage asasuitablesolutionforthereductionofrelateddiversificationinthed i v e r s i f i c a t i o n compa nies.
The disparity in research results regarding the level of diversification in Vietnam compared to previous studies may stem from differences in the dataset used, which includes 118 non-financial companies listed on HOSE and HNX from 2009 to 2014 Following the global financial crisis and the European public debt crisis, companies sought to avoid stagnation and enhance production efficiency by implementing diversification strategies However, economic downturns may lead companies, particularly smaller ones or those underperforming, to exercise caution in investments and increase cash reserves to mitigate sudden economic shocks Many companies may refrain from unrelated diversification, focusing instead on accumulating capital to improve current operations, as such diversification is often deemed inefficient Additionally, debt leverage plays a crucial role in influencing diversification decisions as a trade-off Furthermore, discrepancies in study outcomes may arise from limitations in the data collection process, as advertising expenditure is often underreported in financial statements, necessitating the replacement of the variable ln(Ad_Ex) with Capex.
Dep.Var:ln(TDL) OLS 2SLS 3SLS
(Thesampleincludeddataofnon- financialcompaniesfrom2009to2014.Thedependentvariableln(TDL)isthenaturallogarithm ofleverage;R_entropyisthedegreeofrelatedd i v er s i fi c a t i o n ; U_entropyisthedegreeof unrelateddiversification;ln(Tobin'sq)isthen a t u r a l logarithmofqofTobin;QRistheratioo ftotalcash,shortterminvestmentsanda c c o u n t s receivabledividedtotalcurrentliabilities
;ln(Capx)isthenaturallogarithmofcapitalexpenditures;ln(Sales)isthenaturallogarith mofnetrevenue.*,**,***significantlevelat1%,5%,1 0 % C o e f f i c i e n t s o f y e a r d u m m i e s w e r e n o t r e p o r t e d S t an d a r errorwerereportedasthenumberinparenthesis)
Table4.5showstheregressionresultsoftheimpactofdiversification,firmperformancet o c apitalstructure.TheHausmanspecificationtestisnosignificant,sothenull hypothesi si s n o t r e j e c t e d T h e r e f o r , H a u s m a n t e s t d e m o n s t r a t e s t h a t 3 S L
61 efficicentandconsistentthan2SLS Theimpactsofthetwotypesofdiversification o nt h e l e v e r a g e a r e o p p o s i t e Whiler e l a t e d d i v e r s i f i c a t i o n i s p o s i t i v e e f f e c t o n l e v e r a g e ( 1 4 0 9 a t t h e 1 0 % s i g n i f i c a n t l e v e l ) , t h e u n r e l a t e d d i v e r s i f i c a t i o n i s s h o w n t o h a v e a s t r o n g l y n e g a t i v e impactonleverage(-
Companies that engage in related diversification tend to finance their investments with debt, as this strategy fosters operational collaboration through shared information, skills, and technology transfer, ultimately enhancing firm value Access to funds from banks and bond markets enables these companies to create favorable conditions for inter-unit operations, build interdependencies, and foster collaboration to increase overall value Managers focusing on operational efficiency and cost savings may find it easier to secure loans from debt holders However, under the influence of debt holders, managers might face constraints on investment decisions, potentially leading to inefficient project selections or cost overruns To maintain financial support, they must prioritize maximizing shareholder profits and timely interest payments to debt holders, which may necessitate cuts to expansion plans or divestitures Additionally, banks and bond markets are often reluctant to lend to companies pursuing unrelated diversification strategies, especially when there is uncertainty regarding safeguarded profits.
1.160at1%significancelevelin3SLSmodel.T r a d e – o f f t h e o r y s u g g e s t e d thatc o m p a n y wantst o c r e a t e a n o p t i m a l c a p i t a l struc tureatwhichthemarginalbenefitofdebtequalsthemarginalcostofdebtandf i r m p e r f o r m a n c e i s maximized( T a n g a n d J a n g , 2 0 0 7 ; J a n g e t a l , 2 0 0 8 ) 3SLSesti mategivesthe evidence thata negativerelationship betweenfirm performancea ndleverage.Thismeansthat,thehigher- performingcompanywilldecreaseratioofdebttor e d u c e thecostofbankruptcy.Resul
In their studies, Rajan and Zingales (1995) explored the trade-off framework that examines the relationship between firm performance and leverage The pecking-order theory also provides insight into this relationship, suggesting that managers prioritize financing investments through retained earnings, followed by safe debt, risky debt, and finally issuing new shares, to minimize information asymmetry and financial costs According to this theory, the appeal of tax shields is secondary Companies adjust their debt ratios in response to imbalances between internal cash flow, dividends, and real investment opportunities Firms with high profitability tend to utilize less debt leverage compared to others within the same investment opportunities Additionally, Myers and Majluf noted that companies also factor in future investment costs alongside current expenses, highlighting the negative relationship between profitability and debt leverage.
4.4 Effectofdiversificationandcompanyperformancetoleverage
Inter–relationshipamongleverage,freecashflow,diversificationandfirmperformance
Tob e t t e r u n d e r s t a n d t h e s e f i n d i n g s , t h e r e l a t i o n s h i p b e t w e e n c a p i t a l s t r u c t u r e o r d e b t leverageinparticular,f r e e cashflow,diversificationandfirmp e r f o r m a n c e a r e summarizedinthefollowingtwodiagrams:
Figure4.1:Inter– relationshipamongleverage,freecashflow,relatedd i v e r s i f i c a t i o n andfir mperformance
Figure4.2:Inter– relationshipamongleverage,freecashflow,unrelatedd i v e r s i f i c a t i o n andfir mperformance
Research involving 118 non-financial companies listed on the Hanoi and Ho Chi Minh Stock Exchanges reveals that free cash flow negatively impacts firm performance Both related and unrelated diversification strategies harm performance, while capital structure does not directly affect performance but influences it indirectly through changes in free cash flow To enhance performance, companies should limit free cash flow by increasing debt ratios High-performing companies are generally reluctant to engage in diversification, particularly unrelated diversification The study confirms that free cash flow negatively affects firm value when used to finance inefficient projects or serve managers' personal goals To mitigate this, investors may opt to increase debt to reduce financial excesses Furthermore, the relationship between diversification and firm performance shows that implementing diversification strategies, whether related or unrelated to the core business, adversely affects performance Finally, the relationship between diversification and leverage is positive in related diversified companies but negative in unrelated diversified firms.
Improvingfirm’sperformancehasundoutedlybecomeacrucialgoalofmanagersnowada ys.Toattainthisobjective,identifyingthefactors andrelationshipamongthema b s o l u t e l y playani m p o r t a n t r o l e I t i s p r o v e n t h a t t h e r e a r e m a n y f a c t o r s t h a t h a v e impactsonfirmperformance.Oneof themost importantfactorsisthecapitalstructureord e b t leverageofthecompany, theinvestment diversificationintorelated andunrelatedfields,andfreecashflowofthecompany.
Research on leverage and firm performance in Vietnam reveals distinct differences from global studies While traditional findings suggest that leverage positively influences performance through related diversification and negatively affects unrelated diversification, empirical data from Vietnam indicates that leverage has no significant impact on firm performance This discrepancy may stem from Vietnam's unique economic conditions post-2008 financial crisis Additionally, leverage can enhance performance indirectly by reducing free cash flow In related diversified firms, high diversification can diminish firm value, but it does not adversely affect performance Conversely, low cash flow may drive companies to seek new markets, often leading to related diversification A positive relationship between related diversification and debt ratio suggests that increased diversification can elevate agency costs, prompting investors to use leverage as a strategy to mitigate managers' over-investment decisions In contrast, unrelated diversified firms show a verified relationship between diversification levels and performance, indicating that performance can influence diversification strategies, while unrelated diversification appears to lower leverage and remains unaffected by free cash flow.
Knowingt h e s t r o n g r e l a t i o n s h i p b e t w e e n t h e c a p i t a l s t r u c t u r e , f r e e c a s h f l o w , diversificationa n d f i r m p e r f o r m a n c e w i l l h e l p t h e m a n a g e r s n o t o nlytoi m p r o v e f i r m performancewithreasonablestrategiesbutalsotomakedecisionsineffectiv einvestmentselection.Besides,i f t h e f i r m p e r f o r m a n c e isn o t s o g o o d , t h e n t h i s r e l a t i o n s h i p w i l l contributetohe lp m a n a ge r s administrate a moree ff ect iv e way,a v o i d i n g over– investmentproblemandinvestorswillknowthesituationofthefirm,preventprofiteeringf r o m the managers.Basedonstudyresults,thepapergivessomesuggestionsasfollows:
Between 2007 and 2010, many firms invested in industries unrelated to their core sectors, such as real estate and stocks Although Vietnam was not directly impacted by the economic crisis, it still faced inevitable consequences, leading to significant negative changes in the stock and real estate markets, particularly with the latter becoming nearly stagnant in recent years This situation resulted in substantial financial losses for many firms Research indicates that diversification, especially into unrelated industries, should primarily be pursued by larger firms with stable market performance In contrast, small companies facing financial difficulties may experience severe consequences when venturing into new and different industries Therefore, companies must make informed investment decisions to avoid unnecessary losses.
Thevolatilityofcashflows,especiallyfreecashflow,hasgreatinfluenceonthed e v e l o p m e n t o f t h e f i r m I f t h e r e ise x c e s s inf r e e c a s h f l o w , agencyc o s t i s s u e s w i l l appea r.Managerswilltendtoengageinactivitiesthatarenottrulybenefitialtofirms,whi cha f f e c t t h e i n t e r e s t s o f s h a r e h o l d e r s , i n v e s t o r s , a n d c a u s e n e g a t i v e impacto n t h e performanceofthecompany.Thus,companiesneedtopayattentiontocashflowf l u c t u a t i o n s tohaveareasonableinvestmentplan.
Acompanywithlargedebtleveragemaysuffernegativeassessmentsfromthemarket A f t e r thecrisis,investorslookmorecarefullywiththeirfunds.Aventureinvestmentwitha larged ebtleveragefirmisnotthepreferredchoiceinthemarket.However,leverageh a s ap ositiveimpactinlimitingtheexcessivefreecashflow.Themorefreecashflowiscontrolled,t h e b e t t e r f i r m ’sp e r f o r m a n c e w i l l b e T h e r e f o r e , c o n s i d e r i n g w h e t h e r t o f i n a n c e theinvestmentsindebtornotisthethingthatfirmsneedtoconcernandcarefullyc o n s i d e r beforemakinganinvestmentdecision.
This research examines the relationship between four key factors: capital structure, free cash flow, diversification, and firm performance However, it faces several limitations Firstly, the data range differs from the original study, as this analysis includes Vietnamese companies from various sectors, unlike the original focus on restaurant companies, potentially leading to discrepancies with previous empirical results Secondly, the study encounters missing data, particularly for variables such as advertising costs and free cash flow, which can result in measurement errors Additionally, the sample size is relatively small, reducing its representativeness for the Vietnamese market Lastly, the research period spans only six years, from 2009 to 2014, which is insufficient for a comprehensive analysis of the relationships between these factors, especially considering the impact of the financial crisis in Vietnam in 2008 on the research outcomes.
Thel a t e r r e s e a r c h s h o u l d f o c u s morec a r e f u l l y on r e s e a r c h d a t a T h e timeo f r e s e a r c h s h o u l d beexpanded, andshould addmoredata research offirmsonbothHan oiStockExchange( H N X ) a n d H o C h i
M i n h S t o c k E x c h a n g e (HOSE).Thestudyp e r i o d i s extendedwhichwillovercometheimpactofthecrisisontheresearchresults.Besid es,t h e a d d i t i o n o f t h e n u m b e r o f firmsi n t h e samplew o u l d increaser e p r e s e n t a t i o n f o r
Vietnamsemarketandbe capable ofapplicationinlargerpractices.Theexpansionofther e l a t i o n s h i p betweenthefinanci alfactorsofthefirm,outofthefourfactorsmentioneda b o v e wouldbeanattractiveresearchd irectionforfutureresearch.
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No Author Methods Data Mainfindings
OLS) regressionan dGeneralized leastsquaresa nalysis
Inlogingfirms,fixedassets,growt hopportunities,andtheinter- relationshipbetweenthesetwovaria bleshadpositivesignifi cant effec tonfirm’s long-termdebtbehavior
AnalysisofVa ri ance (ANO VA) forcross- sectional
851firmsin25indust riesfrom1962to198 1fromAnnualCom pustat
Optimalleverageofthecompanies hadanegativerelationshipwitht heexpectedcostofthefinancialdist ress,andnon- debttaxbenefits.Atthesametime,t heoptimalfinancialleveragealsoi nverselyr el ated tocompaniesinc omeifconsideringthecostofthefin ancialdistress
Thesefactorsimpactonthecapita lstructuredecisionsamongtheG- 7countriesweresimilar.Tangibleas setsandfirmsizehadapositiveimp actonleverage.Conversely,Marke ttobookandprofitabilityhadanega tiverelationshipwithleverage.
Qualitativeest imates - Companiesshouldfinanceinvest mentbyretainedearnings,thendebta ndfinallythenewequity
- Iftheinvestmentrequiredexcee ded theabilityofcashandlow- riskdebt,companiesshouldignorein vestmentprojectsrat h e r thanissui ngnewequity
- Companiesshouldnotpaya dividendifitisusedtoreplacetheca shwithoutraisingexternalc ap it a l
- Ifthemanagersholdsuperiorinf ormation,thestockpricewould fallwhentheyarereleasedtofina nceinvestment
- Theconsolidationofcompanies withlowandhighcashholdingsw ouldincreasethecompany’scombi nedvalue
T h e companywithhighdebtleve lswillemitasignaltoinvestorsthatt hefuturecashflowsofthecompan yarehighquality.Ifacompanyisr e q ui r e d toissuenewequity,thatwo uldbeanegativesignaltoinvestor s.
- Threest ageleastsq uaresregr essionmo del(3SLS )
- Cross- sectionalsample:10 14ex ch an ge listed non- financialfirmsfro m18emering marketsin1995- 1996
- Time- seriessample:547e xchang elistednon - financialfirmsfro m20emeringmarket sintheperiodof198 0-
- Debtlessenedthereductionin fir mvaluethatfollowaseparationbe tweenamanagementgroup’sc ontrolrightsanditsproportionalc ashflowownership
- Theinternationalloansearnposit ivecumulativeaberrantreturns.T hesecumulativeaberrantreturnsar epositiveaffected ontheseparatio nofcontrol andownership.Thisp ositiverelationisfocusedonfirms withahighlevelofassetsorlessgro wthopportunities
- Initialissuesofpublicinternatio nalbondsledtosi gn i f i can t aber rantreturns,butthesereturnsarenot matchedwithmanagementowne rshipstructures
- Thesampleof15 70firm- yearobservations duringtheperiod of1988-1995.
- Freecashflowincreasedsalesand salesenhancedfirmperformancein casethecompanieshadthelowleve loff r e e cashflow
Usingannua lizedregress ionsfollowin gtheapproach ofFamaand Macbet(197 3)
- Stockpricesactasifinvestorsanti cipatetheconstantofearningsfro mdebtandequity,butoverestimate theconstantofearningsthatisreta inedcashbalance
- Ifthecompanieshadalargep o s i t i v e freecashflow,theywould spendalmostofittofutureinvest mentprojectsw h i ch gainedthelo wermarginalbenefitandtherefore, w o u ld reducethevalueoftheco mpanies
10 Villalong Multivariate -Compustatdata: Unrelateddiversificationgave a,B., regressions 45,998segment- companyadiscountbutrelated
50,708,528 establishment-year observationsof 41,203,605firm- yearin1989-1996
- Companyneedtocreatetheba rrierstoimitationbycompeti torstoensurethesustainability ofcompetitivead vantage
- Therewerefourstepstoimprov ethefirmperformancethroughef ficientrelateddiver sifi catio n
- Asampleof3, 659firmswith 16,181 observations,ofwhi ch5,233aremulti- segmentintheperio dof1986-
- Thediversificationdestroyedthefi rmvalueinalltimeandanysizeoffi rmwhichcanbeexplainbyover- investmentandcross- subsidization
- Apositivesignificanteffectofrel ateddiversificationonfirmvalueh asfoundoutwhichcanbeexplainby theco-insuranceeffect
Asampleof48,773fir ms- yearo bserv at i ons which11,831observa tionsfromdiversifiedfi rmsintheperiodof19 90-
- Leveragereducedthevalueinthe non- diversificationcompaniesbuthadthe positiveeffect onvalueofdiversif iedcompanies
Asampleof308res taurantcompani esinthep erio d of 1995-
- Leveragehasthepositiveeffecton firmperformance,butfir mperform ancehasnoimpacto nleveragedire ctly.Itnegativeeffect onunrelated squares 2829firm- yearobservations diversificationwhichpositiveeffe ct onleverage
- Thefreecashflowincreasediver sificationinbothtwotypes.Andi tderectlydestroyedfirmperforman ce.Anegativeeffectofleverageo nfreecashflowwasalsofound.
- Relateddiversificationhadapos itiveeffectonfirmperformance,buttherelationshipbetweenunr elateddiversificationandfirm performanceisnegative.Debtlev eragecandecreasetherelateddi versificationandunrelateddivers ificationhaspositiveeffectedonl everage
Variable Decription ln(Tobin’sq)it NaturallogarithmictransformedTobin’sqoffirmiatyeart
U_entropyit Unrelatedentropyoffirmiatyeart ln(TDL)it Naturallogarithmicoftotaldebtleverageforfirmiatyeart
Sales_GRit Netsalegrowthoffirmiatyeart ln(Sales)it
TheratioofequityrepurchasetototalassetsforfirmiatyeartD u m m y _ D i v i d e n d it The firm’sdividenddummyvariablewhichhasvalueone iffirmi atyeartpaidoutthedividendandequalszeroiffirmdidnotpaythedi vidend
PPNEit Naturallogarithmicratiooffixedassetstototalassetsforfirmiatyeart ln(Ad_Ex)it Naturallogarithmicofadvertisingexpenditureforfirmiatyeart
Quickr a t i o w h i c h i s d e f i n e d t h e r a t i o b e t w e e n q u i c k a s s e t s a n d currentliabilities.Itrefectstheabilityo f firmto payo u t thecu rr en tl i a b i l i t i e s byt h e q u i c k a s s e t s , n o t u s i n g i n v e n t o r y I t iscalculated bysumo f c a s h a n d s h o r t - t e r m investmenta n d t o t a l receivableovertotalcurrentliability
Ln(Tobin’s q) 708 0.054439 0.374683 -1.0633 1.638896 FCF 708 0.035644 0.173483 -0.65403 0.9166707 R_entropy 708 0.072474 0.14441 0 0.69187 U_entropy 708 0.038798 0.100092 0 0.6279052 Ln(TDL) 708 -0.91272 0.627054 -3.44337 -0.0563218 Cashflow 708 0.115411 0.095163 -0.51623 0.6494679 Sales_GR 708 0.306248 1.967851 -0.73001 42.2235 Ln(Sales) 708 13.55237 1.449882 8.819961 18.11135 Repurchase 708 0.003492 0.048585 -0.03814 1.259968 Dummy_Dividend 708 0.720339 0.44915 0 1 RER 708 0.080609 0.092543 -0.51644 0.4790376 PPNE 708 -1.49951 0.834154 -5.5274 0.0348644 Ln(Ad_Ex) 708 -2.0605 2.154858 -10.0756 0.7612531
The Pearson correlation analysis reveals significant relationships among various financial metrics Notably, cash flow (cf) shows a strong positive correlation with return on equity (rer) at 0.74, indicating that higher cash flow is associated with improved equity returns Additionally, the correlation between net income (lna) and free cash flow (fcf) is positive at 0.14, suggesting a potential link between profitability and cash generation Conversely, there are negative correlations, such as between debt ratio (dr) and net income (lna) at -0.02, indicating that higher debt levels may not directly impact net income Furthermore, working capital (wc) exhibits a positive correlation with return on equity (re) at 0.19, emphasizing the importance of liquidity in enhancing equity performance Overall, the correlations highlight the interconnectedness of financial variables, underscoring the necessity for comprehensive financial analysis.
The Spearman correlation analysis reveals various relationships among key financial metrics Notably, the correlation between lnq and fcf is 0.18, indicating a weak positive relationship The dr metric shows a slight correlation with fcf at 0.06, while du presents a negative correlation of -0.07 with lnq The lnd metric has a significant negative correlation of -0.55 with cf, suggesting an inverse relationship Furthermore, rer shows a strong positive correlation of 0.75 with cf, highlighting its potential impact Other noteworthy correlations include slg with fcf at -0.15 and lns with du at 0.16 Overall, these correlations provide insights into the interconnectedness of financial variables, which could inform strategic decision-making.
Eq Obs Parms RMSE R-sq chi2 P lnq 708 129 0.247269 0.5639 2150.41 0.000 fcf 708 126 0.142682 0.3226 360.76 0.000 dr 708 129 0.070726 0.7598 2389.44 0.000 du 708 128 0.058514 0.6578 1594.56 0.000 lntdl 708 129 0.542343 0.2509 1581.96 0.000 lnq fcf -0.20743 0.121623 -1.71 0.088 -0.44581 0.030948 dr -1.73073 0.858039 -2.02 0.044 -3.41246 -0.04901 du -2.52901 1.210665 -2.09 0.037 -4.90187 -0.15615 lntdl -0.02481 0.072838 -0.34 0.733 -0.16757 0.117954 cashflow 1.121518 0.183585 6.11 0 0.761698 1.481337 sales_gr 0.000275 0.003549 0.08 0.938 -0.00668 0.007232 lnsales 0.095542 0.028838 3.31 0.001 0.03902 0.152063 fcf lntdl -0.18085 0.032086 -5.64 0 -0.24374 -0.11797 rep 0.139898 0.117806 1.19 0.235 -0.091 0.370794
Dum_div 0.045719 0.01579 2.9 0.004 0.014771 0.076666 lnsales 0.053715 0.018804 2.86 0.004 0.016859 0.090571 dr fcf -0.16161 0.044738 -3.61 0 -0.24929 -0.07392 lnq 0.057568 0.065002 0.89 0.376 -0.06983 0.184971 lntdl -0.02422 0.020145 -1.2 0.229 -0.0637 0.015266 rer -0.09217 0.079506 -1.16 0.246 -0.248 0.06366 ppne -0.01656 0.007801 -2.12 0.034 -0.03185 -0.00127 lnad_ex 0.000254 0.001465 0.17 0.863 -0.00262 0.003124 lnsales -0.00512 0.012204 -0.42 0.675 -0.02904 0.018802 du fcf -0.02063 0.02525 -0.82 0.414 -0.07012 0.028856 lnq -0.0995 0.041173 -2.42 0.016 -0.1802 -0.01881 lntdl -0.04489 0.013631 -3.29 0.001 -0.0716 -0.01817 rer 0.032621 0.037369 0.87 0.383 -0.04062 0.105863 ppne 0.008837 0.005128 1.72 0.085 -0.00121 0.018888 lnsales 0.014915 0.009415 1.58 0.113 -0.00354 0.033368 lntdl dr 1.408844 0.809632 1.74 0.082 -0.17801 2.995694 du -8.00734 1.458054 -5.49 0 -10.8651 -5.14961 lnq -1.16042 0.248012 -4.68 0 -1.64651 -0.67432 qr -0.05434 0.009683 -5.61 0 -0.07331 -0.03536 wcap -0.71885 0.142182 -5.06 0 -0.99753 -0.44018 lncapx 0.005699 0.002284 2.5 0.013 0.001223 0.010174 lnsales 0.285282 0.067942 4.2 0 0.152117 0.418446
Exogenousvariables: cashflowsales_grlnsalesrepurchase dummy_dividendrerppnelnad_exqrwcaplncapxi.yeari.id
Eq Obs Parms RMSE R-sq F-Stat P lnq 708 129 0.213145 0.7354 13.65 0 fcf 708 126 0.157501 0.3226 2.35 0 dr 708 129 0.0771 0.767 15.06 0 du 708 128 0.062351 0.6822 10.13 0 lntdl 708 129 0.449123 0.5806 9.82 0
The analysis reveals a negative relationship between free cash flow (fcf) and several variables, including lnq and dr, indicating potential challenges in liquidity management Notably, cash flow demonstrates a significant positive correlation with sales growth, suggesting that increased sales can enhance cash flow Furthermore, the impact of lnsales is substantial, with a strong positive effect on financial performance metrics Conversely, variables such as du and wcap exhibit negative coefficients, highlighting their detrimental influence on cash flow The results underscore the importance of sales performance and liquidity in driving overall financial health, while also pointing to the need for careful management of debt-related factors.
Exogenousvariables: cashflowsales_grlnsalesrepurchase dummy_dividendrerppnelnad_exqrwcaplncapxi.yeari.id lnq 708 12 0.270302 0.4884 55.29 0 fcf 708 9 0.162446 0.1344 12.04 0 dr 708 12 0.144006 0.0225 1.33 0.1932 du 708 11 0.098273 0.051 3.4 0.0001 lntdl 708 12 0.369388 0.6589 111.86 0
Eq Obs Parms RMSE R-sq F-Stat
P lnq fcf -0.07515 0.064988 -1.16 0.248 -0.20257 0.052272 dr 0.092167 0.071028 1.3 0.195 -0.04709 0.231428 du 0.021484 0.104502 0.21 0.837 -0.18341 0.226375 lntdl 0.046517 0.022124 2.1 0.036 0.00314 0.089894 cashflow 2.540322 0.142441 17.83 0 2.261045 2.8196 sales_gr -0.00522 0.005279 -0.99 0.323 -0.01557 0.005132 lnsales 0.03207 0.008096 3.96 0 0.016197 0.047944 fcf lntdl -0.09001 0.010548 -8.53 0 -0.11069 -0.06933
Dum_div 0.050227 0.014369 3.5 0 0.022055 0.0784 lnsales 0.010984 0.004625 2.38 0.018 0.001917 0.020051 dr fcf -0.02887 0.034042 -0.85 0.397 -0.09561 0.037878 lnq 0.030714 0.019276 1.59 0.111 -0.00708 0.068509 lntdl -0.01593 0.011548 -1.38 0.168 -0.03857 0.006709 rer -0.25791 0.080223 -3.21 0.001 -0.4152 -0.10062 ppne -0.00342 0.00666 -0.51 0.607 -0.01648 0.009632 lnad_ex 0.001478 0.002647 0.56 0.577 -0.00371 0.006667 lnsales 0.002084 0.004327 0.48 0.63 -0.0064 0.010568 du fcf 0.045761 0.023084 1.98 0.048 0.0005 0.091021 lnq 0.007081 0.013134 0.54 0.59 -0.01867 0.032831 lntdl -0.01083 0.007842 -1.38 0.167 -0.02621 0.004542 rer -0.05572 0.054341 -1.03 0.305 -0.16226 0.050825 ppne 0.000367 0.004517 0.08 0.935 -0.00849 0.009223 lnsales -0.01115 0.002932 -3.8 0 -0.0169 -0.0054 lntdl dr 0.141998 0.097518 1.46 0.145 -0.0492 0.333197 du 0.323224 0.147894 2.19 0.029 0.033256 0.613193 lnq -0.07156 0.043845 -1.63 0.103 -0.15752 0.014408 qr -0.15065 0.008969 -16.8 0 -0.16823 -0.13306 wcap -1.0045 0.083635 -12.01 0 -1.16848 -0.84053 lncapx -0.00689 0.002848 -2.42 0.016 -0.01248 -0.00131 lnsales 0.09112 0.010644 8.56 0 0.070251 0.11199
2SLS 3SLS Difference S.E. fcf -0.0776 -0.20743 0.1298251 0.1036659 dr -1.29265 -1.73073 0.4380854 0.8144676 du -1.14288 -2.52901 1.386134 1.014509 lntdl 0.069123 -0.02481 0.0939295 0.0549247 cashflow 1.303409 1.121518 0.1818912 0.1225192 sales_gr 0.000838 0.000275 0.0005624 0.0038501 lnsales 0.08359 0.095542 -0.0119515 0.0155906 b=consistentunderHoandHa;obtainedfromreg3B =inconsi stentunderHa,efficientunderHo;obtainedfromreg3
2SLS 3SLS Difference S.E. lntdl -0.18092 -0.18085 -0.0000616 0.0150148 repurchase 0.167666 0.139898 0.0277673 0.064446 dummy_dividend 0.043862 0.045719 -0.0018564 0.0080832 b=consistentunderHoandHa;obtainedfromreg3B =inconsi stentunderHa,efficientunderHo;obtainedfromreg3
Test: Ho: differencein coefficientsnotsystematic chi2(129)
2SLS 3SLS Difference S.E. fcf -0.0994 -0.16161 0.0622081 0.0242282 lnq 0.080692 0.057568 0.0231234 0.038322 lntdl -0.01569 -0.02422 0.00853 0.0112489 rer -0.10898 -0.09217 -0.0168065 0.0557527 ppne -0.01179 -0.01656 0.0047675 0.0046221 lnad_ex 0.000784 0.000254 0.0005308 0.0009928 lnsales -0.01154 -0.00512 -0.0064235 0.0060788 b=consistentunderHoandHa;obtainedfromreg3B =inconsi stentunderHa,efficientunderHo;obtainedfromreg3
2SLS 3SLS Difference S.E. fcf 0.005177 -0.02063 0.0258089 0.0324681 lnq -0.0755 -0.0995 0.0240067 0.0404479 lntdl -0.03433 -0.04489 0.0105594 0.0123898 rer 0.086474 0.032621 0.0538526 0.0650088 ppne 0.013231 0.008837 0.0043939 0.0052203 lnsales 0.005582 0.014915 -0.0093339 0.0049687 b=consistentunderHoandHa;obtainedfromreg3B =inconsi stentunderHa,efficientunderHo;obtainedfromreg3
2SLS 3SLS Difference S.E. dr 0.672174 1.408844 -0.73667 1.796291 du -5.64236 -8.00734 2.364984 1.950059 lnq -0.80198 -1.16042 0.358438 0.16957 qr -0.07833 -0.05434 -0.02399 0.017595 wcap -0.74136 -0.71885 -0.02251 0.171589 lncapx 0.000968 0.005699 -0.00473 0.00392 b=consistentunderHoandHa;obtainedfromreg3B =inconsi stentunderHa,efficientunderHo;obtainedfromreg3