INTRODUCTION
Problem statement
Corporate governance principles establish a framework that enables firms to meet their objectives and effectively manage performance This framework focuses on the interactions among management, the board, and shareholders Research shows that robust corporate governance enhances firm success by minimizing agency conflicts and optimizing capital structure, as supported by both theoretical and empirical evidence (Jensen 1986; Klock et al 2005; G20/OECD principles of corporate governance 2015).
Numerous empirical studies have explored the impact of corporate governance on capital structure over time, with a particular focus on the relationship between managerial entrenchment and leverage ratio This topic has garnered significant interest from academics, practitioners, and policymakers alike, highlighting its importance in understanding corporate financial strategies.
Managerial entrenchment, as defined by Berger, Ofek, and Yermack (1997), occurs when managers manipulate financing decisions to serve their own interests over those of shareholders, often leading to increased leverage Jensen and Meckling (1976) argue that entrenched managers may exceed optimal debt levels to mitigate takeover risks and enhance their job security, a view supported by Harris and Raviv (1988), Stulz (1988), and Wald and Long (2007), who link stronger anti-takeover measures to higher leverage ratios Conversely, Welch (2004) suggests that after benefiting from significant stock returns, entrenched managers may prefer issuing equity over debt, resulting in lower debt ratios Additionally, John et al (2008) indicate that concerns about financial distress lead managers to adopt conservative investment strategies, further contributing to reduced leverage.
The interplay between managerial entrenchment and market timing behavior in relation to leverage ratios remains underexplored Market timing significantly influences managers' financing decisions, impacting whether companies opt for debt or equity to fund investment opportunities Therefore, this study aims to simultaneously analyze managerial entrenchment and market timing behavior to provide a comprehensive understanding of their effects on leverage ratios.
Entrenched managers tend to limit debt levels and make responsible investment decisions to avoid bankruptcy, which can effectively mitigate takeover threats (Zwiebel, 1996) However, this avoidance of debt restricts firms from benefiting from tax-shield advantages associated with low-cost funding When external financing is needed, these managers are more inclined to issue significant equity, particularly when market conditions appear favorable (Graham and Harvey, 2001) This behavior aligns with market timing theory, where a firm's capital structure reflects past efforts to optimize equity market conditions (Baker and Wurgler, 2002) Research by Kayhan and Titman (2007) indicates that a firm's history, including financial deficits and stock price movements, plays a critical role in influencing its leverage ratio through market timing behavior.
In Vietnam, there is a scarcity of studies exploring the impact of managerial entrenchment and the market timing effect on firms' leverage ratios, despite the prevalence of trade-off and pecking order theories in existing literature, such as Vo and Tran (2015) The nascent stage of Vietnam's securities market contributes to information asymmetry and agency problems, complicating firms' abilities to accurately estimate stock prices and determine optimal leverage levels Nguyen (2015) identified both short-term and long-term effects of market timing on the leverage levels of Vietnamese IPO firms, highlighting the significance of sector value deviations and historical stock prices in equity issuance and market timing However, this research overlooked the roles of managerial entrenchment and firm histories Therefore, this paper aims to fill the gap in empirical evidence regarding these factors within the Vietnamese context.
Research objectives
This study aims to examine how managerial entrenchment and market timing effects, influenced by a firm's history, affect its leverage ratio The research focuses on four primary objectives to uncover these relationships.
(i) Analyzing the determinants of managerial entrenchment together with firms’ characteristics that influence leverage ratio of Vietnam firms
(ii) Evaluating the target leverage ratio of Vietnam firms
(iii) Estimating the effect of managerial entrenchment and the market timing presented through firms’ characteristics on leverage ratio
(iv) Examining the relationship of managerial entrenchment in both high and low entrenchment regime and firm’s histories on leverage ratio in Vietnam firms
This study is different from other previous studies on the following grounds:
For the first time in Vietnam, this study examines the impact of managerial entrenchment and market timing effects on the leverage ratios of all firms listed on the Ho Chi Minh Stock Exchange, highlighting the significance of historical performance in these dynamics.
Second, the effect of managerial entrenchment on firm’s leverage ratio is classified as high entrenchment regime and low entrenchment regime
The article incorporates various measurements of firm characteristics, including financial deficits, leverage deficits, timing measures, and stock price returns Notably, insider sales serve as an effective alternative proxy for assessing timing measures.
Fourth, various econometric techniques including the Ordinary Least
Squares (OLS), the Generalized Method of Moments (GMM) and endogenous switching regression method are employed in this study.
Research questions
In attempts to achieve the above objectives, the following four research questions have been raised:
(i) What are the determinants of managerial entrenchment and which are firms’ factors that significantly influence leverage ratio in Vietnam firms?
(ii) Do Vietnam firms use target leverage and apply the market timing theory to determine leverage ratio?
(iii) How do managerial entrenchment and the market timing effect presented through firms’ histories affect leverage ratio in Vietnam firms?
(iv) How do managerial entrenchment in both high and low entrenchment regime and firm’s histories affect leverage ratio in Vietnam firms?
Research scope
This study analyzes a dataset of 289 non-financial firms from the Ho Chi Minh Stock Exchange (HOSE) covering the period from 2006 to 2015 The secondary data was gathered from various sources, including annual reports, financial statements, and firm information available on websites such as cafef.vn, cp68.vn, and vietstock.vn Financial firms, including banks, insurance companies, and investment funds, were excluded from the sample due to their distinct capital structures compared to non-financial sector firms.
The thesis structure
This thesis comprises five chapters The main content of each chapter is organized as follows:
Chapter 1 introduces an overview of the thesis containing the problem statement, the research objectives, questions, and the research scope
Chapter 2 explores existing theories and empirical evidence related to agency conflicts, managerial entrenchment, market timing, and firm characteristics It subsequently outlines the research hypotheses and establishes a conceptual framework that examines the factors influencing firms' leverage ratios.
Chapter 3 describes the methodology including the data measurements and quantitative models employed in the thesis Additionally, econometric technique used to achieve the research objectives will be elaborated
Chapter 4 expresses the empirical results In particular, main findings are revealed and compared to other empirical evidences
Chapter 5 provides the key findings and the discussions The implications are delivered to shed light on the policy purposes Finally, the chapter indicates the limitations for future improvements.
LITERATURE REVIEW
Literature review
Corporate governance principles establish a vital framework that enables companies to reach their objectives while effectively managing performance This framework emphasizes the interactions among management, the board, and shareholders Strong corporate governance is essential for fostering firm success in management and finance by minimizing agency conflicts and optimizing capital structure As a result, these principles provide policymakers with effective tools to promote economic growth and ensure financial stability.
Klock et al 2005; G20/OECD principles of corporate governance 2015)
Corporate governance principles do not offer a one-size-fits-all model for every country; instead, they amalgamate common elements from diverse corporate structures These principles outline various objectives and methods for establishing an effective corporate governance framework This flexibility allows management to develop their own governance systems tailored to meet the expectations of shareholders and debtholders, as highlighted in the G20/OECD Principles of Corporate Governance 2015.
2.1.1.2 Why does corporate governance matter for an organization?
According to Hart (1995), corporate governance issues arise from two main factors: the agency relationship, which highlights the conflict of interest between an organization's owners and its management, and agency costs, which stem from this conflict and persist despite contractual agreements.
Corporate governance principles are designed to address conflicts of interest between owners and management Globalization plays a crucial role in reducing these conflicts by enabling companies to access international capital markets and attract investments from developed countries As companies establish strong connections with global capital flows, adherence to corporate governance standards becomes more prevalent, aligning with international best practices Effective oversight and mechanisms enhance shareholder and debtholder confidence, leading to a reduction in capital costs and an increase in wealth for both owners and management This creates a mutually beneficial relationship, as outlined in the G20/OECD principles of corporate governance (2015).
2.1.2 The theoretical framework of corporate governance
Jensen and Meckling (1976) introduced agency theory, highlighting the relationship between firm owners and top management, which arises from the separation of ownership and control In this framework, shareholders and debtholders act as principals, while top managers are considered the agents.
An agency relationship is established through an agreement between principals and agents, where the agent acts on behalf of the principals to make decisions aimed at maximizing the owners' wealth However, the agent may not always align with the principals' best interests due to the complexities of a utility-maximizing relationship.
To safeguard their interests, principals implement incentives to curb the abnormal behaviors of agents One key strategy is to enhance managerial ownership, which compels managers to prioritize shareholder wealth over personal interests However, increased power can lead to managerial entrenchment, where managers become less susceptible to replacement or punishment by principals This entrenchment often results in managers exploiting their position to influence investment opportunities in ways that favor their own well-being (Morck, Shleifer, and Vishny 1988).
Debt financing serves as a significant deterrent against managers' tendencies to pursue empire-building, as highlighted by Grossman and Hart (1982) and Jensen (1986) The potential risk of bankruptcy due to increased leverage compels managers to enhance operational efficiency and closely monitor investment projects This focus on generating adequate cash flows ensures that firms can meet future interest and principal payments, ultimately fostering a more disciplined approach to financial management.
Signaling theory highlights that agency relationships arise not only from conflicts of interest between owners and management but also from asymmetric information between insiders (top managers) and outsiders (shareholders and debtholders) Insiders typically possess more information about the firm's investment opportunities than outsiders, prompting the latter to seek information from various sources However, access to the true value of a firm's current and future investments is often restricted, necessitating verification of the information's reliability Consequently, shareholders and debtholders may be vulnerable to financing changes initiated by insiders An increase in debt levels signals to outsiders an expectation of higher future cash flows, while financing through new equity issuance may suggest a decline in the firm's performance, leading outsiders to share losses with new investors Thus, outsiders often interpret an increase in leverage as a sign of management's confidence in the firm's future performance.
Jensen and Meckling's (1976) influential research on corporate governance emphasizes that capital structure theory is essentially synonymous with ownership structure theory They argue that key indicators of capital structure extend beyond mere debt and equity totals, also encompassing the equity stakes held by managers.
Therefore, three determinants of the capital structure is incorporated to illustrate the theory for a given size firm
The total market value of the equity is calculated as:
𝑆 = 𝑆 𝑖 + 𝑆 0 The total market value of the firm is measured by:
Si: inside equity (held by the manager),
S0: outside equity (held by outside investors of the firm),
B: debt (held by outside investors of the firm)
The theory is developed to determine the optimal ratio of outside equity to debt (Jensen and Meckling 1976)
The determination of the optimal ratio of outside equity to debt is
The firm's size is considered constant, with V representing its actual value influenced by agency costs V* denotes the firm's value at a specific scale when agency costs are nonexistent Meanwhile, the total amount of outside financing, represented by B + S0, remains fixed, and the optimal proportion of this outside financing is derived from equity.
The optimal ratio of outside equity to debt is determined by analyzing total agency costs, represented as A T (E), which depend on the amount of outside equity For a firm of size V ∗ and total outside financing (B + S 0), total outside financing is defined as E ≡ S 0 ⁄ (B + S 0) The agency costs associated with outside equity are denoted as A S 0 (E), while those related to debt are represented as A B (E) The minimum total agency costs occur at the optimal fraction of outside financing, E ∗, where A T (E ∗) is achieved.
Figure 2.1 illustrates two key components of agency costs: (i) total agency costs associated with the equity held by the owner-manager, represented as A S 0 (E), and (ii) total agency costs related to the debt amounts, denoted as A B (E) Overall, the total agency cost is influenced by these factors.
The agency costs related to the amounts of equity held by the owner-manager is
When E ∗ is equal to zero, it indicates a lack of outside equity, represented by the equation E ∗ ≡ S ∗ ⁄(B + S 0 ) In this scenario, any increase in total equity corresponds directly to the equity held by outside investors Consequently, managers may be incentivized to exploit outside equity minimally, resulting in an increase in agency costs, denoted as A S 0 (E).
A GENC Y C OS T S ( M E A S U R E D I N U N IT S OF CU R R E N T W E A L T H)
FRACTION OF OUTSIDE FINANCING OBTAINED FROM EQUITY
Agency costs associated with debt, denoted as A B (E), arise from the decline in firm value and the monitoring expenses linked to the transfer of wealth from bondholders to managers, which incentivizes managers to enhance their equity value These agency costs reach their peak when external financing is entirely sourced from debt, resulting in S 0 = E = 0 Conversely, when all external funds are derived from equity, agency costs are minimized.
Empirical evidence
2.2.1 The influence of managerial entrenchment on leverage ratio
Research by Kim and Sorensen (1986) and Stulz (1988) demonstrates that higher managerial ownership positively influences leverage ratios, suggesting that it helps mitigate agency costs associated with equity issuance Supporting this, Agrawal and Mandelker (1987) note that managers with significant ownership are more inclined to increase debt ratios, even in the face of potential financial distress Additionally, John and Litov (2010) reveal that entrenched managers, who have better access to debt markets, tend to elevate their firms' leverage ratios Furthermore, Bin-Sariman, Ali, and Nor (2016) argue that managerial entrenchment, along with the quality of the board of directors, contributes to an increase in debt ratios.
Research by Friend and Lang (1988), Bathala, Moon, and Rao (1994), and Chen and Steiner (1999) indicates that companies with higher levels of managerial ownership tend to have lower debt ratios, as management is concerned about increasing financial risk Additionally, findings from Berger, Ofek, and Yermack support this relationship.
(1997), Becht, Bolton and Rửell (2003), Hermalin and Weisbach (2003), Holderness
Research by Novaes and Zingales (2003) and Kayhan (2008) indicates that entrenched managers often reduce debt ratios due to the impact of rising stock prices linked to market timing Additionally, Ganiyu and Abiodun (2012) found a negative relationship between managerial entrenchment and leverage ratios in listed firms in Nigeria, which is supported by findings from Wen, Rwegasira, and Bilderbeek (2002) and Quang and Xin in China.
2.2.2 The impacts of firms’ histories on leverage ratio
2.2.2.1 Financial deficit and Leverage ratio
Myers and Majluf (1984), Shyam-Sunder and Myers (1999) and Baker and Wurgler
In 2002, it was established that financial deficit plays a crucial role in the pecking order theory and market timing effects Financial deficit, or external finance, refers to the net amount of debt and equity that a firm issues and repurchases within a given year.
According to pecking order theory, as proposed by Myers (1984) and others, firms increase their external capital in response to high financial deficits or low free cash flow, which results in higher leverage Conversely, when firms have sufficient free cash flow, their leverage tends to decrease as they utilize retained earnings to cover financial deficits and reduce debt However, Frank and Goyal (2003) challenge this theory, indicating that both large and small firms are significantly influenced by financial deficits, leading them to prioritize equity issuance over debt financing.
Market timing influences managerial preferences for raising external capital, with studies by Baker and Wurgler (2000), Kayhan and Titman (2007), and Kayhan (2008) indicating that managers favor equity over debt due to their ability to time the equity market, leading to reduced debt financing Additionally, research by Law and Chong (2011) highlights that financial deficits adversely impact the leverage ratios of Thai firms.
2.2.2.2 Market timing and Leverage ratio
A timing measure indicates that companies are more likely to raise funds through equity rather than debt when stock prices rise, as highlighted by Baker and Wurgler (2002).
Baker and Wurgler (2002) identified two types of timing measures related to financial deficits: yearly timing and long-term timing, as outlined by Kayhan and Titman (2007) The yearly timing measure reflects the covariance between total external finance and the market-to-book ratio, indicating that equity issuance can lead to increased funds due to short-term overvaluation, as seen in the current market-to-book ratio compared to previous years In contrast, the long-term timing measure assesses the market-to-book ratio in relation to both the firm's historical ratios and the ratios of all firms in the market, highlighting broader market influences.
Seyhun (1986, 1990) and Liu (2009) utilize insider sales as a market timing indicator, calculated as the percentage of net volume from secondary share offerings relative to total shares outstanding at the year's end.
As a result, the author points out that the market timing variable is insignificant to leverage
2.2.2.3 Stock price returns and Leverage ratio
Graham and Harvey (2001) align with the findings of Hovakimian, Opler, and Titman (2001) and Welch (2004), indicating that elevated stock prices often lead to increased equity issuance Conversely, falling stock prices typically trigger share repurchases Consequently, stock returns significantly and negatively affect the leverage ratio.
Research by Kayhan and Titman (2007), Kayhan (2008), and Law and Chong (2011) indicates that the difference between one-year stock returns and prior years' returns serves as a market timing proxy Their findings suggest that firms experience a decrease in leverage ratio when they capitalize on high market stock returns.
Hypotheses
2.3.1 Managerial entrenchment effect and Leverage ratio
According to Novaes and Zingales (1995, 2003), managers often manipulate their debt choices to enhance their job security and maintain their positions In response to increased takeover pressures, they tend to reduce debt levels as a strategy to mitigate risks associated with tighter punishment mechanisms.
Jung, Kim, and Stulz (1996) reveal that firms prioritize equity issuance over debt financing, particularly when faced with limited investment opportunities Their research indicates that companies that issue equity possess a greater investment capacity compared to those that rely on debt The study highlights that entrenched managers often opt for equity issuance due to significant agency costs, even when debt financing could yield better outcomes for firm value.
Research by Berger, Ofek, and Yermack (1997), as well as Kayhan and Titman (2007) and Kayhan (2008), indicates that a decrease in debt ratio is linked to the managerial entrenchment effect This phenomenon suggests that managers utilize debt financing as a means to shield themselves from performance pressures, mitigate the risks associated with under-diversified investment choices, and secure their positions during their tenure.
Hypothesis 1 There is a negative relationship between managerial entrenchment and leverage ratio
2.3.1.1 Block-holder holdings and Leverage ratio
Beneficial ownership refers to the percentage of shareholdings held by block-holders, defined as those owning at least 5 percent of a company’s shares These block-holders act as representative owners and can significantly influence managerial decisions, including leverage ratios and control over managerial entrenchment However, there is evidence suggesting that block-holders may align with managers, often at the expense of minority investors.
Furthermore, the dominant presence of block-holders shares nothing in common with important corporate decisions, increasing managerial entrenchment (Holderness 2003)
Berger, Ofek and Yermack (1997) and Kayhan (2008) indicate that a rising of block-holder holding brings about a decrease in leverage ratio
Hypothesis 2 The higher proportion of block-holder holdings gives rise to the higher of managerial entrenchment and the lower of leverage ratio
2.3.1.2 Board size and Leverage ratio
Research by Jensen (1993) and Wen, Rwegasira, and Bilderbeek (2002) indicates that larger board sizes positively influence leverage ratios, as these boards are more inclined to increase debt to enhance corporate value However, Yermack (1996) argues that in cases of significant agency conflicts, larger boards may lead to entrenched and free-riding managers, resulting in diminished control over management and financing decisions, including leverage ratios Further insights by Berger, Ofek, and Yermack (1997) and Kayhan support these findings, highlighting the complexities of board size and its impact on corporate governance.
(2008) and Quang and Xin (2013) provide a negative relationship between board size and leverage ratio due to managerial entrenchment
Hypothesis 3 Board size has a negative impact on leverage ratio
2.3.1.3 Director age and Leverage ratio
Research indicates that boards dominated by older directors often lead to increased managerial entrenchment, resulting in less effective monitoring and potentially higher CEO turnover (Berger, Ofek, and Yermack, 1997; Vafeas, 2003) Furthermore, older directors are typically inclined to avoid raising debt ratios, prioritizing their own interests over the company's financial strategies (Berger, Ofek, and Yermack, 1997; Wen, Rwegasira, and Bilderbeek, 2002; Kayhan, 2008).
Hypothesis 4 Older directors save firms from a surge in leverage ratio
2.3.1.4 CEO-Chairman duality and Leverage ratio
When CEOs hold both the CEO and chairman positions, they often make financing and leverage decisions without oversight, resulting in increased managerial entrenchment This unchecked decision-making can negatively impact financing choices, as highlighted by studies from Berger, Ofek, and Yermack (1997), Kayhan (2008), and Ganiyu and Abiodun (2012).
Hypothesis 5 The duality role of managers negatively impacts leverage ratio
2.3.1.5 Board composition and Leverage ratio
Hermalin and Weisbach (2003) argue that outside directors face restricted access to firms' information, resulting in increased managerial entrenchment Their research indicates that a greater presence of outside directors on the board correlates with heightened CEO entrenchment regarding leverage decisions Furthermore, to mitigate the scrutiny from outside directors, managers tend to reduce leverage ratios, thereby alleviating the pressure of substantial fixed interest obligations.
Hypothesis 6 The percentage of outside directors on the board is in association with a decline in leverage ratio
2.3.1.6 CEO age and Leverage ratio
Experienced CEOs holding dual positions significantly influence management dynamics, enhancing their bargaining power with the board and reducing their vulnerability to performance evaluations.
Older CEOs tend to limit the growth of a firm's leverage ratio as a strategy to enhance corporate governance and secure their positions (Goyal and Park, 2002; Berger, Ofek, and Yermack, 1997; Wen, Rwegasira, and Bilderbeek, 2002; Kayhan, 2008).
Hypothesis 7 CEO age exhibits a negative relation to leverage ratio
2.3.2 The relationship between firms’ histories and leverage ratio
2.3.2.1 Financial deficit and Leverage ratio
According to pecking order theory, as proposed by Myers (1984), Myers and Majluf (1984), and Shyam-Sunder and Myers (1999), firms typically increase their external capital in response to high financial deficits or low free cash flow, resulting in higher leverage Conversely, when firms have sufficient free cash flow, their leverage tends to decrease, as they can utilize retained earnings to address financial deficits and reduce debt However, contrary to this theory, Frank and Goyal (2003) argue that both large and small firms are significantly influenced by financial deficits, leading them to favor equity issuance over debt financing.
Market timing influences managerial preferences for raising external capital, as highlighted by Baker and Wurgler (2000), Kayhan and Titman (2007), and Kayhan (2008) Managers tend to favor equity over debt financing, believing they can capitalize on favorable equity market conditions, which ultimately leads to a reduction in debt financing.
Hypothesis 8 There remains a negative effect of financial deficit on leverage ratio
2.3.2.2 Market timing measures and Leverage ratio
Baker and Wurgler (2000) highlight two distinct types of timing measures related to financial deficits, as identified by Kayhan and Titman (2007): yearly timing and long-term timing The yearly timing measure assesses the covariance between total financial deficit or external finance and the market-to-book ratio, indicating that equity issuance can increase funds due to short-term overvaluation reflected in the current market-to-book ratio compared to previous years Conversely, the long-term timing measure evaluates the market-to-book ratio in relation to both the firm's past ratios and those of all firms in the market, suggesting that an increasing market-to-book ratio signals better growth opportunities Consequently, this implies that debt financing should be preserved for future needs, as noted by Law and Chong (2011).
Liu (2009) utilizes insider sales as a market timing indicator, calculated by the percentage of net volume from secondary share offerings relative to total shares outstanding at year-end This insider sales variable reflects the difference between the number of shares sold and the number of shares purchased.
Repurchased shares are linked to rising stock prices, while shares are sold when prices increase (Seyhun, 1986) According to Seyhun (1990), insider sales enable top managers to achieve an approximate 3 percent return on their transactions As stock prices rise, insider transactions by managers increase, indicating a preference for equity issuance over debt financing.
Hypothesis 9 An increase in market timing measures attributes a decline to leverage ratio
2.3.2.3 Stock price returns and Leverage ratio
Analytical framework
This study presents a conceptual framework that simultaneously examines the impact of managerial entrenchment and the historical context of firms on their leverage ratios.
RESEARCH METHODOLOGY AND DATA
Vietnam’s corporate governance and securities market framework
3.1.1 Vietnam’s corporate governance and institutional background
3.1.1.1 Vietnam’s adoption of corporate governance standards
The G20/OECD principles of corporate governance which were first publicized in
In 1999, guidelines were established for Vietnamese firms to enhance their corporate governance framework, with significant improvements made in 2004 and again in 2015 These principles were translated into Vietnamese and incorporated into the Law on Enterprises 2005 (Law No [insert number]).
The National Assembly's 60/2005/QH11 highlights the need for improvements in the understanding and application of its principles Despite some adaptation, significant legal gaps remain that must be addressed Key issues include the unclear ownership structure and its functions, as well as the lack of transparency in financial information.
The corporate governance assessments in Vietnam conducted in 2006 and 2013 identified several critical issues, including the limited capacity and resources of institutions to effectively regulate and develop the market Additionally, shareholders face inadequate institutional protections, and their access to information regarding agency conflicts is restricted by management.
In 2010, the Baseline Report on the Vietnam Corporate Governance Scorecard revealed that the corporate governance practices of the 100 largest listed companies in Vietnam scored below 50 percent, as reported by the International Finance Corporation and the State Securities Commission of Vietnam.
3.1.1.2 Vietnam’s corporate governance legal framework
The legal framework for corporate governance in Vietnam is primarily based on regulations and the Law on Enterprises 2005, which are enforced through both primary and secondary legislation by the government Consequently, Vietnamese enterprises are required to adhere to the stipulations set forth in the Law on Enterprises.
Enterprises 2005 On the contrary, Vietnam firms are exposed to some following weaknesses
The legislation regarding conflicts of interest between owners and management remains unclear and inconsistent According to the Law on Enterprises 2005, the general meeting of shareholders (GMS) represents shareholders and has the authority to elect and remove board members However, when conflicts escalate to a level necessitating legal intervention, the GMS lacks the ability to initiate class action lawsuits against the board, as this provision has not been updated in the law Furthermore, protections for minority shareholders appear inadequate, allowing large shareholders with political ties to evade legal consequences Consequently, minority shareholders are often exploited while larger shareholders prioritize their own interests, highlighting the ineffective nature of current legislation in addressing agency conflicts.
The Vietnam firms’ corporate governance structures are not well designed
Shareholders’ self-regulate is confined and corporate accountability principles have yet to be flexible and adaptable in response to rapid change in business environment (Minh and Walker 2008)
The corporate charter is essential for establishing corporate governance in Vietnamese firms, outlining key elements such as objectives, structure, and operations It offers greater emphasis on minority shareholder protection compared to the Law on Enterprises 2005 However, many corporate charters in Vietnam are not distinct and often mirror the common standards set by the Model Charter 2007, as mandated by the Ministry of Finance Consequently, the enforcement of corporate charters remains weak, leading to ongoing neglect of minority shareholder rights (Freeman and Nguyen 2006).
3.1.2 The background of Vietnam’s securities market
The 1986 economic renovation, known as Doi Moi, prompted Vietnam to initiate market reforms and establish a securities market, leading to the formation of the State Securities Commission (SSC) in November 1996 As the principal regulator of capital markets, the SSC oversees market intermediaries and public enterprises under Decree No 48/1998/ND-CP Regulated by the Law on Securities 2006, the SSC supervises the Ho Chi Minh Stock Exchange (HOSE) and the Hanoi Stock Exchange (HNX), while also collaborating with the Ministry of Finance to publish corporate governance principles and charters for public companies.
The formation of the securities regulatory framework is a direct result of these statements, as highlighted by Nguyen and Eddie (2003) and the International Finance Corporation in collaboration with the State Securities Commission of Vietnam in both 2006 and 2013.
The growth of Vietnam's securities market faces challenges despite initial successes in implementing a securities administration system There is a pressing need to expand equity and debt instruments and enhance the variety of options available Transparency in financial information is crucial for investor access, while educating both Vietnamese investors and SSC staff is vital for market development Additionally, the technology infrastructure of the two Securities Trade Centers requires significant improvement The market's scale does not align with the country's potential growth due to the absence of major industries, and securities companies have struggled to effectively act as intermediaries between capital demand and supply Furthermore, market vulnerability is heightened by the manipulation of a large number of shares by a small group of influential investors.
Established in 2000, the Ho Chi Minh Stock Exchange (HOSE) began with only two listed companies, reflecting its initial modest size Despite its early stage of development, HOSE has become a significant symbol of Vietnam's financial landscape, attracting greater attention than the Hanoi Stock Exchange due to its larger enterprises and higher foreign investment Companies seeking to list on HOSE must meet stringent requirements, including a minimum capital and profit threshold for at least two years prior to listing (Nguyen and Eddie 2003; International Finance Corporation and the State Securities Commission Vietnam 2013).
Despite its challenges, the establishment of the Ho Chi Minh Securities Trade Center plays a crucial role in developing Vietnam's financial system, particularly as the country transitions from a centrally planned economy to a market-oriented one.
The steady expansion of the securities market is closely linked to advancements in market infrastructure and the overall financial landscape A well-structured securities market reflects the economic development of emerging financial markets, ultimately contributing to greater stability and confidence for future growth.
Data sources
This study analyzes a dataset comprising 289 non-financial firms from the Ho Chi Minh Stock Exchange (HOSE) between 2006 and 2015 The secondary data was sourced from various platforms, including annual reports, financial statements, and official websites like cafef.vn, cp68.vn, and vietstock.vn Financial institutions such as banks, insurance companies, and investment funds were excluded from the sample due to their distinct capital structures, which differ from those of non-financial firms.
Research methodology
This section comprises three analytical components First, the Ordinary Least Squares (OLS) method is utilized in a two-stage approach to identify the target leverage level and to estimate independent variables, including leverage deficit and changes from the target leverage This analysis aims to quantify the effects of managerial entrenchment and the historical context of firms on their leverage ratios Second, the Generalized Method of Moments (GMM) is applied to enhance the robustness of the results.
Moments (GMM) is used to eliminate the endogeneity problem caused by financial deficit – a determinant of firms’ characteristics to leverage ratios Third, with the aid of
Endogenous switching regression method, the impact of managerial entrenchment in both high and low regime together with firms’ characteristics on leverage ratios is specified
3.3.1 The two-stage approach in determining leverage ratios
3.3.1.1 The target leverage ratio estimation
Following Kayhan and Titman (2007), the Ordinary Least Square (OLS) method is utilized to construct the target leverage
L Target it : Target leverage level of firm i in year t,
M/B: Growth opportunities – the market-to-book ratio of firm i in year t,
PPE: Property, plant and equipment of firm i in year t,
EBIT: Profitability of firm i in year t,
R&D: Research and development expense of firm i in year t,
SE: Selling expense of firm i in year t,
SIZE: Firm size of firm i in year t
The target leverage is measured by the predicted value from the Ordinary Least
The Ordinary Least Squares (OLS) regression analysis incorporates key observed variables, including profitability measured by EBIT, asset tangibility represented by PPE, research and development expenses (R&D), selling expenses (SE), firm size (SIZE), and the market-to-book ratio (M/B).
X5: Research and development dummy (R&D dummy)
Firm size (SIZE) = Ln (Sales)
This study investigates the relationship between managerial entrenchment and firms' leverage ratios by employing Ordinary Least Squares (OLS) and Generalized Method of Moments (GMM) methodologies Following the frameworks established by Kayhan and Titman (2007) and Kayhan (2008), the regression model incorporates two dependent variables: the book leverage ratio and the market leverage ratio It also examines three categories of independent variables: pecking order theory (financial deficit and profitability), market timing theory (yearly timing, long-term timing, and stock returns), and trade-off theory (leverage deficit and changes in target leverage).
The model which is applied to estimate the impact is performed as follows
Also, leverage deficit (LDEF) and change in target leverage (ΔTARGET) is constructed from the target leverage estimation
L it − L i(t−n) : Difference in leverage ratio of firm i in year t, t-n,
FD: Financial leverage of firm i in year t, t-n,
YT: The yearly timing measure of firm i in year t, t-n,
LT: The long-term timing measure of firm i in year t, t-n,
R: Stock price histories of firm i in year t, t-n,
MEs: Managerial entrenchment variables of firm i in year t, t-n,
EBIT: Profitability of firm of firm i in year t, t-n,
LDEF: Leverage deficit of firm i in year t, t-n,
ΔTARGET: Change in target leverage of firm i in year t, t-n
Leverage ratios, including book leverage and market leverage, are essential financial metrics Book leverage, defined as the ratio of book debt to total assets, is often viewed as backward-looking, reflecting historical debt levels in relation to asset value In contrast, market leverage, which compares the book value of debt to the combined book value of debt and market value of equity, is considered forward-looking, as it relates total debts to the current market valuation of the firm This distinction highlights the different perspectives these ratios provide on a company's financial health.
Five – Block-holder holdings – Beneficial ownership is defined as the percentage of block holder holdings (at least 5 percent of shareholdings)
Block-holders are the representative owners of a company This means that a large number of block-holders may have a great influence on the manager’s decisions, controlling and reducing managerial entrenchment
Board size: number of directors on the boards A large board results in a negative relationship between the board and the management process by virtue of agency conflicts (Yermack 1996)
Board size = Ln (Board size)
The age of directors, indicated by the logarithm of the median age on the board, plays a significant role in corporate governance Firms with boards dominated by older directors often experience increased managerial entrenchment Research by Vafeas (2003) suggests that such older boards may lack effective monitoring, leading to a higher turnover rate of CEOs.
Director age = Ln (Median director age)
The dual role of CEO and Chairman often results in unrestricted decision-making regarding financing and leverage, contributing to increased managerial entrenchment (Goyal and Park, 2002) This relationship is measured using a dummy variable, which assigns a value of 1 when the CEO also holds the chairman position and 0 when they do not.
CEO-Chairman duality = 1 if CEO is chairman; 0 otherwise
The composition of the board, specifically the percentage of outside directors, plays a crucial role in influencing CEO entrenchment in leverage decisions Research by Hermalin and Weisbach (1988, 2003) indicates that a higher proportion of outside directors correlates with an increased level of CEO entrenchment.
Older CEOs, with their extensive experience and established reputations, tend to exert a significant influence on internal control mechanisms This age-related advantage grants them greater bargaining power in negotiations with the board and makes them less susceptible to scrutiny, as highlighted by Berger, Ofek, and Yermack (1997).
CEO age = Ln (CEO age) Firms’ histories:
A financial deficit is calculated by summing investment (I), dividends (DIV), changes in working capital (ΔWC), and net cash flow (CF), then dividing this total by the total assets This metric provides insight into a company's financial health by reflecting the relationship between its investments, returns, and cash management.
The financial deficit is discussed in the studies of Shyam-Sunder and Myers
(1999), Frank and Goyal (2003), Kayhan and Titman (2007), and Kayhan
Timing measures indicate that companies tend to issue equity when their stock prices are rising and opt for debt financing when prices are falling (Baker and Wurgler, 2002) These measures include the yearly timing measure (YT) and the long-term timing measure (LT) (Kayhan and Titman, 2007) The yearly timing measure assesses the covariance between a firm's financial deficit and its market-to-book ratio, while the long-term timing measure involves comparing the market-to-book ratios of different firms.
Insider sales, a key alternative timing measure, is calculated by taking the difference between shares sold and shares repurchased, divided by the total number of shares at the end of the year This metric serves as a short-run market timing proxy, as established by researchers like Seyhun and Lee Data on insider trading, which includes buy and sell transactions made by top executives such as CEOs and chairpersons, is publicly available on websites like cafef.vn and vietstock.vn.
Stock returns are calculated using the logarithm of the difference between the ending share price (P1) and the starting share price (P0) for a financial year, plus any dividends (DIV), all divided by the initial share price (P0).
Profitability is the sum of earnings before interest, and taxes (EBIT) divided by total assets
Leverage deficit refers to the gap between a firm's actual leverage and its target leverage This concept suggests that firms with leverage ratios lower than their target are likely to increase their debt levels, while those with higher leverage ratios tend to reduce their debt.
Change in target leverage (ΔTARGET) is the difference between the current target leverage ratio and the previous target leverage ratio
Change in target leverage (ΔTARGET) = 𝐿 𝑇𝑎𝑟𝑔𝑒𝑡 𝑖𝑡 − 𝐿 𝑇𝑎𝑟𝑔𝑒𝑡 𝑖,(𝑡−𝑛)
Industry dummy is the Vietnam standard industry codes (VSIC) to regulate characteristics of Vietnam industry
Book leverage The book leverage is the ratio of book debt to total assets Book leverage = Book debt
Market leverage is a financial metric that represents the ratio of a company's book value of debt to the combined total of its book value of debt and the market value of its equity This ratio is calculated using the formula: Market Leverage = Book Debt / (Book Debt + Market Value of Equity) Understanding market leverage is crucial for assessing a firm's financial risk and capital structure.
Total assets − Book equity + Market equity
Five The percentage of block-holder holdings (at least 5 percent of shareholdings) Five = Shareholdings of beneficial investors
Board size The number of directors on the boards Board size = Ln (Board size)
Director age The logarithm of median age of director on the board Director age = Ln (Median director age)
CEO-Chairman duality The variable is a dummy variable that equals to 1 when CEOs are also the chairman and 0 as CEOs are not the chairman
CEO-Chairman duality = 1 if CEO is chairman; 0 otherwise
Board composition The percentage of number of outside directors on the board Board composition = Number of outside directors on the board
CEO age The logarithm of CEO age CEO age = Ln (CEO age)
Financial deficit The ratio between the sum of investment (I), dividends (DIV), changes in working capital (ΔWC), and net of cash flow (CF) divided by total assets
Financial deficit (FD) = Investment+Dividends+∆Working capital−Cash flow
Yearly timing The yearly timing is the covariance between financial deficit and market-to-book ratio
Yearly timing (YT) = ∑ t−1 FD ∗ (M/B) s s=0 ⁄ − FD t ̅̅̅̅ ∗ M/B ̅̅̅̅̅̅ = Cov (FD, M/B)
Long-term timing The long-term timing is formed by comparing one firm’s market-to- book ratio to another firm
Long-term timing (LT) = ∑ t−1 s=0 (M/B) s /t ∗ ∑ t−1 s=0 FD s ⁄ t = M/B ̅̅̅̅̅̅ ∗ F/D ̅̅̅̅̅
Insider sales are calculated by determining the ratio of the difference between the number of shares sold and the number of shares repurchased to the total number of shares outstanding at the end of the year The formula for insider sales at time t is represented as: Insider sales t = Number of selling shares t - Number of repurchased shares t This metric provides valuable insight into insider trading activities and company performance.
Number of shares at the end of a fiscal year t
THE EMPIRICAL RESULTS
Data descriptions
Table 4.1 summarizes the descriptive statistics of sample mentioned in the study
On average, book leverage is 45.20%, while market leverage stands at 55% This book leverage ratio is comparable to that of Chinese companies at 44.57%, Thai enterprises at 44.36% and 42.79%, and US firms ranging from 46.10% to 47.50%.
The ratio observed is significantly higher when compared to Dutch firms, which stand at 8.00 percent, and listed companies in the Asia-Pacific region, including Australia at 18.56 percent, Malaysia at 26.97 percent, and Singapore at 24.01 percent.
UK corporations have a market leverage ratio of 16.79 percent (Florackis, 2009), which is significantly lower than that of companies in the US (35.60 percent - Kayhan, 2008; 39.50 percent - Liu, 2009), Thailand (43.59 percent - Law and Chong, 2011), and the Netherlands (7.50 percent - De Jong and Veld, 2001) In comparison, the leverage ratio for UK companies stands at 9.73 percent (Florackis, 2009), highlighting a notable difference in market leverage across these countries.
Many firms in Vietnam heavily rely on debt financing, prompting an examination of how factors such as managerial entrenchment and corporate histories impact their leverage ratios.
The managerial entrenchment effect reveals that the average CEO is 47 years old, with 38.30 percent of companies having a CEO-Chairman duality Additionally, the board of directors significantly impacts decision-making, controlling 48 percent of the total shares in the company.
Firm characteristic determinants play a crucial role in three distinct capital structure theories According to the pecking order theory, financial deficit significantly impacts capital structure, contributing 29.60 percent, which surpasses the figures reported for US firms Additionally, the market-to-book ratio indicates that an increase in total assets results in higher book and market debt ratios, accounting for 70.60 percent Book profitability (EBIT book) contributes 8.30 percent, while market profitability (EBIT market) accounts for 15.40 percent In the market timing theory, yearly and long-term timing measures account for 10.90 percent and 16.50 percent, respectively, whereas insider sales, an alternative proxy, only represent 3.80 percent The mean one-year stock returns stand at 8.30 percent, closely aligning with the 8.80 percent observed for US firms.
In 2004, the impact on leverage deficits differed significantly from that of Thai companies, showing a decline of -11.97 percent (Law and Chong, 2011) The trade-off theory variables revealed that the mean book leverage deficit was -2.50 percent, while the market leverage deficit stood at -9 percent Notably, the change in book target leverage was recorded at 47.70 percent, in contrast to a 63.90 percent change in market target leverage.
Table 4.1 Descriptive statistics The sample comprises 289 listed companies in Ho Chi Minh Stock Exchange from 2006 to 2015
Variables Measurement Obs Mean Std Dev Min Max
Total assets − Book equity + Market equity
Block-holder holdings Shareholdings of beneficial investors
Board size Ln (Board size) 2890 9.584 4.078 3 34
Director age Ln (Median director age) 2890 44.342 6.564 26 62
CEO-Chairman duality CEO-Chairman duality = 1 if CEO is chairman; 0 otherwise 2890 0.383 0.486 0 1
Board composition Number of outside directors on the board
CEO age Ln (CEO age) 2890 47.585 7.916 24 72
Financial deficit Investment + Dividends + ∆Working capital − Cash flow
Insider sales Number of selling shares 𝑡 − Number of repurchased shares t
Number of shares at the end of a fiscal year t
Book leverage deficit L − L Book Target 2890 -0.025 0.197 -0.571 0.874
Book target leverage change L Book Target it
Market target leverage change L Market Target it
Market-to-book Total assets − Book equity + Market equity
Property, plant and equipment Net property, plant and equipment
Research and development Research and development
Table 4.2 highlights various dimensions of managerial entrenchment, including the number of block-holders' shareholdings, board size, the age of board directors, CEO-Chairman duality, the presence of outside directors, and the age of the CEO Overall, it indicates that larger boards tend to have a significant presence of outside directors (0.505) and block-holders (0.107), suggesting a correlation between board size and external control.
Furthermore, older CEOs on board (0.307) are virtually assigned a title of CEO and Chairperson (0.151) at the same time
Table 4.2 Correlation among managerial entrenchment proxies Table 4.2 presents the correlation among the managerial entrenchment variables
Five Board size Director age Duality Outside director CEO age
In Table 4.3, the correlation between the book and market leverage ratio, the managerial entrenchment effect and the firm characteristics is displayed
A large board size with older directors, more outside director, and the senior CEO who is appointed as the chairperson results in an increase in the book leverage ratio
A larger board composed mainly of external members, alongside older directors and CEOs, negatively impacts the market leverage ratio This dynamic leads to a decrease in debt levels while increasing the reliance on equity issuance for financing investments.
According to the pecking order theory, managers prioritize using retained earnings from profits to meet investment needs, viewing debt and equity financing as secondary options This approach helps reduce financial distress by using profits to pay off debt, leading to lower leverage Consequently, an increase in financial deficit and profitability (EBIT) is inversely related to the leverage ratio.
Market timing theory suggests that after stock prices rise, companies should prefer equity issuance over debt financing due to potential overvaluation This approach assesses external capital through equity based on stock price evaluations The pecking order theory complements market timing by analyzing market-to-book ratios, with yearly timing reflecting a firm's current market-to-book against previous years and long-term timing comparing different firms An increasing market-to-book ratio indicates better growth prospects and reduced financial deficits, leading managers to favor equity issuance Consequently, this strategy preserves borrowing capacity for future needs.
The trade-off theory highlights the dilemma firms face regarding the benefits and drawbacks of debt when addressing financial deficits To mitigate bankruptcy risks, managers often reduce the debt ratio as financial deficits rise Leverage deficit represents the gap between actual leverage and target leverage, indicating a negative correlation where an increase in leverage deficit results in a lower leverage ratio Additionally, changes in target leverage reflect how quickly the observed leverage ratio adjusts relative to its intended target.
Table 4.3 Correlation among managerial entrenchment, firms’ histories and firms’ leverage ratio
This Table 4.3 describes the correlation between leverage ratios and the firm characteristics and the managerial entrenchment variables
Variables Book leverage Market leverage
To provide a visual view of the relationship between managerial entrenchment and firm characteristics to the book leverage and market leverage ratio, Figure 4.1, Figure 4.2, and Figure 4.3 are represented
Figure 4.1 illustrates the relationship between managerial entrenchment and both book and market leverage ratios In the context of book leverage, factors such as the presence of block-holders, board size, and the age of the CEO and directors, along with CEO-Chairman duality, contribute to a higher level of entrenchment, positively impacting the book leverage ratio Conversely, board size and the age of the CEO and directors negatively affect the market debt ratio.
Financial deficits, profitability, and leverage deficits negatively impact leverage ratios, as shown in Figure 4.2 Firms prefer to utilize retained earnings from profits rather than relying on external debt to address financial deficits This approach leads to a leverage deficit, where the actual leverage observed significantly exceeds the target leverage ratio.
Figure 4.3 illustrates a strong correlation between market timing proxies and leverage ratios, indicating that both yearly and long-term timing measures, alongside insider sales and stock returns, significantly contribute to a reduction in debt ratios.
Figure 4.1 Managerial entrenchment effect The correlation of managerial entrenchment and leverage ratios is displayed by graph
Figure 4.2 Firm characteristics The correlation of firm characteristics and leverage ratios is illustrated by graph
Figure 4.3 Market timing effect The correlation of market timing and leverage ratios is presented by
4.2 The target leverage ratio estimation
Table 4.4 demonstrates the result of the target leverage ratio estimation
The influence of managerial entrenchment effect and firms’ histories on
histories on Vietnam firms’ leverage ratio
4.3.1 The choosing of time period (t-n) – lag order selection for the model specification
The model can be presented as below
L it − L i(t−n) : Difference in leverage ratio of firm i in year t, t-n,
FD: Financial deficit of firm i in year t, t-n,
YT: The yearly timing measure of firm i in year t, t-n,
LT: The long-term timing measure of firm i in year t, t-n,
R: Stock price histories of firm i in year t, t-n,
MEs: Managerial entrenchment proxies of firm i in year t, t-n,
EBIT: Profitability of firm of firm i in year t, t-n,
LDEF: Leverage deficit of firm i in year t, t-n,
ΔTARGET: Change in target leverage of firm i in year t, t-n
Tables 4.5 and 4.6 illustrate the selection of the time period (t-n) and lag order using the Levin-Lin-Chu (2002) test, along with model selection criteria such as the Akaike Information Criterion (AIC) and Bayesian Information Criterion (BIC).
Table 4.5 presents the lag order numbers that meet the criteria for model specification The p-values for lags 1, 2, and 3 are significant at the 1 percent level, while lag 4 does not show significance This indicates that only lags 1, 2, and 3 are relevant for the model.
Table 4.5 Levin-Lin-Chu (2002) test
Book leverage Statistic p-value Market leverage Statistic p-value
To identify the optimal lag order, Table 4.6 utilizes model selection criteria including the Akaike Information Criterion (AIC) and Bayesian Information Criterion (BIC), where lower values indicate a better fit of the variables to the model The bold figures highlight the best information criterion, revealing that a lag number of 3 is deemed the most suitable.
Longer time horizons are essential for accurately observing leverage fluctuations, as firms often do not rebalance their leverage ratios annually due to the high costs involved This necessitates the use of managerial entrenchment proxies and a thorough examination of firms' histories over extended periods The primary reason for this approach is the significant volatility of leverage ratios, which can lead to more meaningful insights when analyzed over time.
Table 4.6 The model selection criteria The model selection criteria includes AIC (Akaike information criterion) and BIC (Bayesian information criterion) Bold numbers denote the best information criterion
Book leverage AIC BIC Market leverage AIC BIC
4.3.2 Multicollinearity, autocorrelation and heteroskedasticity test
Table 4.7 illustrates the multicollinearity assessment through the Variance Inflation Factor (VIF), while Tables 4.8 and 4.9 examine autocorrelation and heteroskedasticity using the Wooldridge test and the Breusch-Pagan/Cook-Weisberg test, respectively.
Table 4.7 demonstrates that the model specifications exhibit no multicollinearity, with the maximum Variance Inflation Factor (VIF) recorded at 3.92 for the model using book leverage as the dependent variable and 3.75 for the model utilizing market leverage as the dependent variable.
Table 4.7 Multicollinearity Variance Inflation Factor (VIF)
Variables VIF – Book leverage VIF – Market leverage
The Wooldridge test for autocorrelation in panel data, as shown in Table 4.8, reveals that the F-statistic's probability is below 5 percent, indicating significance at the 1 percent level Consequently, autocorrelation is present in the model that utilizes book leverage and market leverage ratios as dependent variables.
Table 4.8 Autocorrelation The Wooldridge test for autocorrelation
Table 4.9 presents the results of the Breusch-Pagan/Cook-Weisberg test for heteroskedasticity, indicating a significant chi-squared value at the 1 percent significance level, as the probability is below 5 percent This suggests that there is evidence of heteroskedasticity present in the model.
Table 4.9 Heteroskedasticity The Breusch-Pagan/ Cook-Weisberg test for heteroskedasticity
Prob Chi-squared 0.000 Prob Chi-squared 0.000
The endogeneity problem arises when an independent variable correlates with the error term, with financial deficit identified as an endogenous variable due to favorable debt market conditions that increase external funding and lead to higher financial deficits (Kayhan and Titman, 2007) This correlation introduces bias into OLS estimates To assess the endogeneity of financial deficit, the Durbin-Wu-Hausman test is utilized, as illustrated in Table 4.10.
Table 4.10 presents the results of the Durbin-Wu-Hausman test for endogeneity, applied to models utilizing both book leverage and market leverage ratios The null hypothesis posits that the independent variable, financial deficit, is exogenous However, the results indicate that the probability values for both the Durbin (score) Chi-squared and Wu-Hausman F-statistic are below 5 percent, leading to the rejection of the null hypothesis Consequently, this suggests that financial deficit is entirely endogenous.
Table 4.10 Endogeneity test The Durbin-Wu-Hausman test for endogeneity
Durbin (score) Chi-squared 12.372 Durbin (score) Chi-squared 7.076
Prob Chi-squared 0.001 Prob Chi-squared 0.008
4.3.4 Managerial entrenchment effect, firms’ histories and leverage ratio
Table 4.11 illustrates the impact of managerial entrenchment and corporate histories on leverage ratios, specifically the debt ratio, utilizing both pooled Ordinary Least Squares (OLS) and Generalized Method of Moments (GMM) methodologies The analysis incorporates book leverage and market leverage as proxies for assessing firms' leverage ratios.
The OLS estimates reveal that while some managerial entrenchment proxies do not influence the leverage ratio, most significantly affect firms' financing decisions Specifically, four out of six entrenchment proxies—board size, director age, CEO-Chairman duality, and CEO age—demonstrate a significant impact on the book leverage ratio at a 1 percent level Larger boards with older directors tend to issue less book debt, resulting in a lower book leverage ratio Additionally, CEOs holding dual positions, particularly those who are older and have longer tenures, restrict increases in the book leverage ratio Conversely, older directors negatively impact the market leverage ratio, leading to a substantial reduction in it.
The influence of a firm's history on its leverage is primarily reflected in the book leverage ratio, which is shaped by factors such as profitability (EBIT), market timing (long-term timing and stock returns), and trade-off considerations (leverage deficit) Overall, the historical performance of firms plays a significant role in determining their market leverage ratios.
Endogeneity, autocorrelation, and heteroskedasticity in the error term lead to biased Ordinary Least Squares (OLS) estimates, as discussed in Section 3.2.2 The presence of autocorrelation and heteroskedasticity is validated by the Wooldridge test, as shown in Table 4.8, along with the Breusch-Pagan test results.
The Cook-Weisberg test (Table 4.9) indicates that financial deficit is an endogenous variable, as confirmed by the Durbin-Wu-Hausman endogeneity test (Table 4.10) To enhance the efficiency and validity of the estimation, the Generalized Method of Moments (GMM) is utilized, following the methodology outlined by Hansen.
CONCLUSION AND POLICY IMPLICATIONS
Concluding remarks
Corporate governance principles serve as a vital framework for companies to meet their objectives, emphasizing the interactions among management, the board, and shareholders Research indicates that effective corporate governance enhances firm success by minimizing agency conflicts and optimizing capital structures The impact of corporate governance on capital structure has been extensively studied, with particular focus on the relationship between managerial entrenchment and leverage ratios, drawing significant interest from academics, practitioners, and policymakers alike.
This study analyzes a sample of 289 non-financial firms listed on the Ho Chi Minh Stock Exchange from 2006 to 2015, aiming to address key gaps in corporate governance research within the Vietnamese context For the first time, it examines the influence of corporate governance and managerial entrenchment, along with market timing behavior, on the leverage ratio Managerial entrenchment is assessed through various factors, including block-holder holdings, board size, director age, CEO-Chairman duality, board composition, and CEO age, while market timing behavior is evaluated using the historical leverage ratio, defined as the ratio of book leverage to market leverage Additionally, the study categorizes the impact of managerial entrenchment on a firm's leverage ratio into two distinct regimes: high entrenchment and low entrenchment.
This study employs a two-stage approach to analyze the leverage levels of listed firms in Vietnam, focusing on determining the target leverage level and assessing the impact of managerial entrenchment and firm histories on actual leverage To achieve this, a range of econometric techniques is utilized, including the Generalized Method of Moments (GMM) and the endogenous switching regression method, alongside the traditional Ordinary Least Squares (OLS) method.
Key findings achieved from this study can be summarized as below
Empirical evidence reveals a negative relationship between managerial entrenchment and leverage ratio, suggesting that entrenched managers often opt to reduce leverage by issuing equity, reflecting market timing behavior Furthermore, the study identifies a negative impact of firms' historical financial deficits and timing measures, along with stock price histories, on the leverage ratios of Vietnam’s listed companies during the research period.
A large board comprised of older directors and CEOs, along with a CEO-Chairman duality, aims to reduce the book leverage ratio In contrast to the managerial entrenchment effect associated with book debt, the presence of more block-holders and outside directors on larger boards contributes to a lower market leverage ratio.
Financial deficits negatively affect leverage ratios, indicating that firms, wary of financial distress from investments surpassing internal cash flow, limit their debt levels Additionally, profitability, measured by EBIT, contributes to a reduced leverage ratio as firms prefer to utilize retained earnings for investment needs and to service existing debt This reflects the pecking order theory, where external financing is viewed as a last resort for firms.
Market timing proxies, including yearly timing, long-term timing, and stock returns, have a negative impact on the leverage ratio This finding aligns with the market timing behavior exhibited by firms seeking to raise external finance, as supported by Baker and Wurgler (2000).
According to Kayhan and Titman (2007) and Kayhan (2008), rising stock returns draw investors' interest, leading to increased demand for corporate shares and enabling firms to opt for equity issuance instead of debt financing A firm's market-to-book ratio plays a crucial role in determining both yearly and long-term timing for these financial decisions A higher market-to-book ratio indicates better growth opportunities and a reduction in financial deficits, prompting managers to favor equity issuance over debt Consequently, this approach preserves borrowing capacity for future needs.
When insider sales are used as an alternative measure for timing in the market, it reveals that firms do engage in market timing, as insider sales and stock returns have a negative impact on leverage ratios Insider sales are represented by the difference between the number of shares sold and purchased Share repurchases typically occur when stock prices decline, while sales of shares happen during price increases As stock prices rise, insider trading activity increases, indicating a preference for equity issuance over debt financing Furthermore, with rising stock returns, shares become more appealing to investors, prompting managers to favor equity issuance, which ultimately reduces the book debt ratio.
The study reveals a significant negative relationship between leverage deficit and leverage ratio, indicating that firms tend to issue more equity than debt Consequently, the current leverage ratio deviates from its targeted level Notably, the adjustment towards the new target market leverage ratio occurs at a faster pace compared to the book leverage ratio This suggests that managers in Vietnam do not adhere to the established target leverage ratio.
This study highlights the influence of both high and low managerial entrenchment regimes, along with firms' histories, on book and market leverage ratios The findings indicate that managers with high entrenchment tend to focus on market timing, leveraging opportunities in the equity market to their advantage, which ultimately leads to a reduction in the leverage ratios of their firms.
The results indicate that the high managerial entrenchment regime includes larger number of block-holders, larger boards, older CEOs with CEO-Chairman duality and more outside directors
This study provides empirical evidence indicating that changes in leverage ratios negatively respond to financial deficits, profitability (EBIT), and various timing measures, including yearly and long-term timing, as well as insider sales and stock price returns Notably, the reduction in debt ratios is significantly influenced by the presence of highly entrenched managers.
The significant influence of entrenched managers on the board may indicate weak corporate governance in Vietnam, as highlighted by reports from the International Finance Corporation and the State Securities Commission of Vietnam.
(2006) and International Finance Corporation and the State Securities Commission Vietnam (2012).
Policy implications
This study investigates the impact of managerial entrenchment and corporate histories on the leverage ratios of publicly listed companies in Vietnam The research presents empirical findings that highlight these influences, leading to recommendations for policymakers, the Government of Vietnam, and relevant authorities, as well as for the listed firms themselves.
5.2.1 The implications for listed firms in Vietnam
To listed firms in Vietnam, varieties of proposals are provided to support the companies in achieving successful corporate governance framework and promoting their ability to compete with other enterprises
It is crucial for top executives and company owners to recognize the significant role of board members in shaping strategic planning and monitoring within their organizations Board members offer valuable insights that help achieve corporate objectives However, when entrenched managers dominate decision-making, board members often lack influence over key corporate choices Therefore, executives and owners must carefully weigh the advantages and disadvantages of entrenched managerial power to ensure effective governance.
The corporate governance principles established in 2004 and 2015, along with the Vietnam corporate assessment report from 2012, play a crucial role in enhancing the governance of Vietnam’s listed firms by leveraging the expertise of experienced outside directors on their boards These directors, who possess financial acumen and relevant industry knowledge, can help mitigate the risks associated with managerial entrenchment, where entrenched managers often prioritize their own interests over those of the firm By applying effective external pressures, management is compelled to adhere to corporate governance mechanisms that protect owners' interests and ensure accountability within the organization.
Firms' management must clearly define the roles of outside directors, adhering to Circular 121/2012/TT-BTC issued by the Ministry of Finance on July 26, 2012, which provides essential guidelines for public company management By taking full responsibility for assigning tasks and overseeing performance, management can effectively differentiate the roles and responsibilities of independent directors from those of non-executive directors The inclusion of outside directors not only enhances the strategic development of companies but also reduces managerial entrenchment, ultimately promoting an increase in market value.
This study reveals that managerial entrenchment negatively impacts leverage ratios, as entrenched managers prefer issuing equity over debt to capitalize on perceived market timing advantages Such managers believe equity financing is less costly than debt, leading to increased agency conflicts between management and shareholders When equity is favored, it signals to debtholders potential risks, heightening information asymmetry and conflicts of interest The unpredictable nature of the securities market further exacerbates the risk of stock mispricing and potential profit losses from poor market timing decisions As a result, the value of debtholders, shareholders, and the firm itself may suffer Therefore, Vietnamese listed firms must carefully balance debt and equity roles in their capital structure decisions.
5.2.2 The implications for Vietnam’s investors
Findings from this empirical study are also to provide evidence for investors to consider their investment strategy in Vietnam’s stock market
Investor education is crucial for the growth of Vietnam's securities market, as a comprehensive understanding of enterprise law is essential for investors in the country.
With the help of improving understanding of the law, investors understand more clearly about their rights in order to protect themselves and their investments from interest of conflicts
Shareholders must demand complete transparency in corporate documentation to access previously restricted information and scrutinize company operations during instances of managerial entrenchment By establishing robust corporate governance mechanisms and threatening to dismiss managers, owners can effectively curb managerial entrenchment If management fails to comply, shareholders have the option to sue for withholding information and infringing on their rights or ultimately choose to withdraw their investments from the company.
Debtholders must conduct thorough investigations into all investment projects, as entrenched managers may manipulate leverage ratios to finance poor investments for their own benefit To mitigate risks associated with these bad investments, creditors can either increase interest rates or cease debt financing altogether.
5.2.3 The recommendations to the Government of Vietnam and relevant authorities
To the Government of Vietnam and relevant authorities, some following suggestions are proposed to fill in the legal gaps
The Government must ensure that all listed companies adhere to legal standards and corporate governance frameworks, not only by monitoring their physical activities and financial management but also by enforcing strict compliance with enterprise laws.
Doing sure is to ensure that ignoring legal requirements and the framework will be detected so that the legal framework will be progressively adjusted, revised and completed
The Government and relevant authorities must finalize Circular 121/2012/TT-BTC, issued by the Ministry of Finance on July 26, 2012, which outlines management prescriptions for public companies Despite the document's plausible interpretation, its application has not been consistently or conveniently implemented by companies Therefore, there is a pressing need for a clearer and more comprehensible resolution to be established.
The regulations should provide a clearer definition of outside directors, as the current general concept lacks sufficient detail regarding the distinct roles and responsibilities of independent directors compared to non-executive directors on boards Outside directors play a vital role in executing corporate development strategies and overseeing the compensation and rewards of executive directors This presence encourages managers to adhere to corporate governance mechanisms, thereby potentially reducing the effects of managerial entrenchment.
The government must enhance awareness regarding the significant influence of separate board powers in Vietnam's listed companies As entrenched managers often dictate the primary strategic directions, the interests of the firm may be compromised, leading to resources being utilized to benefit these managers rather than the company as a whole.
Due to managerial entrenchment and market timing, firms often overlook the significance of debt in favor of equity when seeking external funding for investments This equity-centric approach sends negative signals to debtholders, exacerbating information asymmetry and increasing conflicts of interest between management and owners In Vietnam's nascent securities market, these issues can lead to mispriced stocks and diminished firm value, ultimately jeopardizing the interests of both debtholders and shareholders.
In this way, the policymakers are obligated to generate the availability of transparent market information and to improve the meticulousness of designed regulations
5.3 The limitation and further improvement
This research explores the influence of managerial entrenchment and corporate histories on leverage ratios within the Vietnamese context, representing a key example of emerging markets Despite its insights, the study acknowledges certain limitations that warrant further investigation.
The dataset quality poses challenges to the research objectives, primarily due to its limited timespan of just ten years (2006-2015), which may affect the long-term estimation of corporate governance's impact on managerial entrenchment and market timing in relation to firms' leverage Additionally, the disclosure of corporate governance characteristics, such as voting index and CEO protection index, is hindered by a culture of secrecy among Vietnamese firms, compounded by non-compliance with laws regarding accurate annual report publication This lack of transparency could undermine the reliability of the findings Furthermore, incorporating data from additional developing countries with similar characteristics to Vietnam would enhance the robustness and persuasiveness of the research outcomes.