UNIVERSITY OF ECONOMICS HO CHI MINH CITY International School of Business TRUONG HANH DUYEN DEBTS AND PROFITABILITY AN EXAMINATION OF MANUFACTURING FIRMS LISTED ON VIETNAM STOCK EXCHANGE MASTER OF BUSINESS (Honours) SUPERVISOR: Dr. PHAM QUOC HUNG Ho Chi Minh City – Year 2012 Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 2 of 44 TABLE OF CONTENT 6TAcknowledgement6T 3 6TAbstract6T 4 6TCHAPTER 1: INTRODUCTION6T 5 6T1.16T 6TVietnam Context:6T 5 6T1.26T 6TManufacturing firms in Vietnam:6T 6 6T1.36T 6TResearch Objective:6T 7 6T1.46T 6TResearch structure:6T 10 6TCHAPTER 2: LITERATURE REVIEW6T 11 6T2.1 The concept of debts:6T 11 6T2.2 The concept of profitability:6T 12 6T2.3 Relationship between debts and profitability:6T 14 6T2.4 Theoretical Framework:6T 17 6T2.5 Hypotheses Development:6T 18 6TCHAPTER 3: RESEARCH METHODOLOGY6T 20 6T3.1 Research Design:6T 20 6T3.2 Variables Definition:6T 21 6T3.3. Samples Collection:6T 22 6T3.4. Methods of Data Analysis:6T 24 6TCHAPTER 4: EMPIRICAL RESULTS & DISCUSSION6T 26 6TCHAPTER 5: IMPLICATIONS & CONCLUSIONS6T 30 6T5.1. Implication:6T 30 6T5.2. Limitation:6T 31 6T5.3. Conclusion:6T 32 6TReferences6T 33 6TAppendix 1: Outliners6T 36 6TAppendix 2: Normality and Heteroskedasticity6T 37 6TAppendix 3: MLR between Net margin and independent variables6T 39 6TAppendix 4: MLR between ROE and independent variables6T 42 Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 3 of 44 Acknowledgement I would like to gratefully acknowledge the enthusiastic supervision of Dr. Pham Quoc Hung during this work. I thank Prof. Nguyen Dinh Tho for the technical discussions on the spectral response model, optical measurements and relevant discussions. Staff of International School of Business (ISB) – University of Economy Ho Chi Minh is thanked for numerous supports. I am grateful to all my friends and classmates from Mbus 1 – ISB for sharing science materials and knowledge during the years I study there and for their continued moral support there after. From the staff, Mr. Duong Minh Toan and Mr. Ho Sze Ming are especially thanked for their care and attention. Finally, I am forever indebted to my husband for his understanding, endless patience and encouragement when it was most required. Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 4 of 44 Abstract The ability of companies in determining suitable financial policies to make investment opportunities is one of the most principal factors for the companies’ growth and progression. Adopting a debt policy or a capital structure is considered as a momentous decision that influences the companies’ value. The determination of a company’s capital structure constitutes a difficult decision, one that involves several and antagonistic factors, such as risk and profitability. That decision becomes even more difficult, in times when the economic environment in which the company operates presents a high degree of instability. Therefore, the choice among the ideal proportion of debt and other resources can affect the value of the company, as much as the return rates can. In this study, I tried to examine the influence of debts from Vietnam manufacturing firms regarding the factor profitability. The necessary data, which are used in this work are the 3 consecutive years’ financial reports provided by the 200 respective firms. The Ordinary Least Squares (OLS) method was employed in the estimation of a function relating the net margin and return on the equity (ROE) with the indexes of long-term, short-term and total debts, and also with the total of owner’s equity. The results indicate that short-term debt presents a negative impact on net margin. The study recommends that managers should be careful while using short term debts as a source of finance. Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 5 of 44 CHAPTER 1: INTRODUCTION This chapter includes three sections. The first section introduces Vietnam Context in recent years, which is also the background of the research. The second is some briefs of manufacturing firms in Vietnam and its vital role in the whole economy, thus the research is to focus on this sector. The third section goes straightly to research objective as a conclusion for two sections above and an opening for following chapters. 1.1 Vietnam Context: Vietnam’s transition, from a centrally planned economy to a market economy and from an extremely poor country to a lower-middle-income country in less than 20 years, is now a case study in many development textbooks. But Vietnam’s other transition, to becoming an industrialized and modern economy by 2020, has barely begun. The latest Socio-Economic Development Strategy (2011-2020) goes on to identify the country’s key priorities to meet this ambitious target: stabilize the economy, build world-class infrastructure, create a skilled labor force, and strengthen market-based institutions. Meeting these aspirations will not be easy. The country has experienced bouts of macroeconomic turbulence in recent years: double-digit inflation, depreciating currency, capital flight, and loss of international reserves eroding investor confidence. Rapid growth has revealed new structural problems. The quality and sustainability of growth remain a source of concern, given the resource-intensive pattern of growth, high levels of environmental degradation, lack of diversification and value addition in exports, and the declining contribution of productivity to growth. Vietnam’s competitiveness is under threat because power generation has not kept pace with demand, logistical costs and real estate prices have climbed, and skill shortages are becoming more widespread. Until a few years ago, Vietnam was one of the world's hottest emerging markets. Now it faces an urgent task: fix a beleaguered banking system or watch its economy continue to slip behind faster-growing neighbors. Piles of bad loans following the financial crisis have dragged down growth in Vietnam and left banks weakened and reluctant to lend, lending interest rate sometimes climbed up to exceedingly 21% per annually in crisis period. Economists warn that Vietnam has entered a dangerous cycle where banks, Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 6 of 44 saddled with bad debts, are unwilling to lend, making it harder for businesses to invest. That feeds into slower growth, which in turn makes it harder for companies to pay back loans, again harming the banks. In a report of government in July 2012, from early 2012 Vietnam recorded about 30,000 of firms are in financials difficulties, temporarily stopping business and declaring bankruptcy. 1.2 Manufacturing firms in Vietnam: Vietnam’s manufacturing sector grew at a compound annual growth rate (CAGR) of 9.3 percent from 2005 to 2010, and labor productivity in the sector increased at 3.1 percent a year. Because this sector accounts for around 30 percent of overall GDP, this rapid growth made a substantial contribution to Vietnam’s expansion during this period. Within manufacturing, some subsectors performed especially well. Motor vehicle production grew at an annual rate of 16 percent during these five years, ready-made clothes by 12.9 percent, and electrical equipment by 12.0 percent. The manufacturing industry plays a vital role in Vietnam’s economy by providing employment opportunities and accelerating its growth. Simultaneously, liberalization, removal of investment restrictions, and semi-privatization of the economy have greatly boosted the country's industrial growth rate. The main manufacturing sectors in Vietnam are textiles and garments, food and beverages and leather and wood. The Government has implemented various programs to transform Vietnam’s economic structure from agriculture-driven to industry-driven and reduce its import dependency. The development of export processing and industrial zones is just one of the initiatives that bolstered the country's industrial growth. The Government has also offered incentives to investors in social sectors such as health and education. However, since liberalization, the Governments share in the overall industrial investment has been declining, thereby enabling higher participation of private and foreign companies. Financial and R&D (research and development) support, as well as the allotment of land in industrial zones, are likely to encourage stakeholders in the manufacturing industry to increase their investments. While sectors such as textiles, leather, food and beverages, automobiles, chemicals and energy were resilient even during the economic downturn, a booming food processing sector, an unsaturated pharmaceuticals market and a dynamic Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 7 of 44 garments sector are expected to add value to the industrial production in Vietnam. The Government has retained the majority of the stake in energy, finance, banking and telecom and shielded the agriculture, food and automobiles sectors from international competition. Higher private and foreign investment had enhanced the growth rate of sectors such as transportation, real estate, communication and mining. However, the country does not permit foreign investments in national defense, security, and health and it places conditional restrictions on investments in telecommunications, postal network and airports. The Vietnamese Governments initiatives and specific incentives for the industrial sector are likely to increase exports and drive the economic growth. Liberalization and the removal of various restrictions generating sector-specific investment opportunities are expected to attract more private and foreign participants to manufacturing industry. Overall, with an aim to become industrialized country by 2020, Vietnam’s manufacturing industry has been undergoing major changes as a result of government initiatives, WTO commitments and industrial liberalization. Industrial development strategy for the period 2011-2020 to focus on the development of Textiles, Leather, Chemicals, Agro processing, Electronics, Automotive, Information and Communications technologies are expected benefit from the industrial development strategy. Due to improving business climate, increased trade and investment cooperation, low labor cost and Vietnam is expected to emerge as a major manufacturing hub in the ASEAN region. Hence, the vitalization of firms in this industry is very important for the growth of country. During crisis period, many firms in sector have been badly affected resulted from high leverage in capital structure. The companies, well overcome such bad cycle of economy, generally do not only well prepare for business operation to maintain profitability, but also less involve in debts by optimal capital structure. 1.3 Research Objective: Which the relationship between debts and profitability? Does the fiscal benefit makes debt more attractive than other funding resource? Does the risk associated to the increase of the debt can, or should, be taken by the firm? Should the financing decisions of the firms follow a single pattern, irrespective of the country where it operates? Those are Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 8 of 44 frequently asked questions that are significantly present in the processes related to decision of capital structure of any firms. Decisions of that type tend to become even more difficult when the economic conditions of the country where the firm operates already are typically more uncertain. In the Vietnamese case, specifically, the presence of two aggravating factors is observed: first is the high interest rates practiced in the financial market, and second is the instability of the economy before the international conjuncture. Those two factors play distinct roles; however, they produce similar effects under the scope of uncertainty. Any firm finances its operation and investment by either debt or equity and mostly both. The firms might like to raise finance from their internal resources, instead of the bank loans and debt issues. Thus the external equity financing is their last option. Conversely, many organizations use debt financing to reduce their cost of capital so that they can lower the “Weighted Average Cost of Capital (WACC)P0F 1 P” as it will allow the firms to have wider extent of acceptance for capital budgeting options. There’s many argument on the relationship of leverage (ratios of debts in asset structure) and business performance before. As a point of departure, the Modigliani and Miller (M&M) (1958) stated: With perfect capital markets and no taxes or information asymmetry, debt financing has no effect on value. However, in a subsequent paper, M&M (1963) eased the conditions and showed that under capital market imperfection where interest expenses are tax deductible, firm value will increase with higher financial leverage. Later, Miller (1977), elaborated a new revision, analyzing the subject of the taxes paid by the investors, concluding that the corporate tax benefits of debt are reduced by the tax penalty due to personal taxation. Models based on impact of tax, suggest that profitable companies should have more debts. However, increasing debt results in an increased probability of bankruptcy. Hence, the optimal capital structure represents a level of leverage that balances bankruptcy costs and benefits of debt finance. 1 A calculation of a firm's cost of capital in which each category of capital is proportionately weighted. All capital sources - common stock, preferred stock, bonds and any other long-term debt - are included in a WACC calculation. All else equal, the WACC of a firm increases as the beta and rate of return on equity increases, as an increase in WACC notes a decrease in valuation and a higher risk. Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 9 of 44 Since all firms’ managers try to get the optimal capital structure with least possible cost, this led in 1984 for the pecking order theory to emerge. The theory began from Myers (1984) states that there is no optimal capital structure for a firm, according to this theory, since there is asymmetric information between managers and shareholders. Therefore to minimize this asymmetric information, firms prioritize their sources of finance (from internal financing to equity) according to the principle of least effort or of least resistance, retained earnings are better than debt and debt is better than equity. But there is another suggestion for case of asymmetric information; managers, directly involve in daily operations of business, thus could master detailed positions of businesses and what are actually being happened in the firms; whilst shareholders mainly rely on the reports from managers, and could be disguised by the beautiful and vivid wordings of those reports. Hence, to make manager be more responsible for their jobs, the firm owners prefer to get more debts rather than equity; repayment obligation of debts and interest occurred push managers work harder to get more profitability in the bottom line of income reports. Due to the importance of the issue and the impact of the financial structure or choice of funding sources on the performance of companies, there are many previous studies and various researches lead us to verify the relationship between capital structures or debts and the performance of companies in different markets generally, but not many for emerging markets and particularly for Vietnam financial market which is characterized as small and unstable. Furthermore, management of capital structures in Vietnam is typically different from others due to components such as high cost of debt, unstable policy and political issues of a social republic country. Unlike previous studies, this paper focuses deeply in the relationship between debts and profitability of listed manufacturing firms on Vietnam Stock Exchange. Specifically, it is aimed at: examining the relationship between Short-term debt, Long-term debt, Total debts, and Net Profit Margin (NM) and Return on Equity (ROE). This study will be significant to managers and shareholders in deciding proportion of debts and each debt types to finance their operations and to maximize firm value which then contributes to the economic development of Vietnam. Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 10 of 44 1.4 Research structure: This thesis comprises five chapters. Chapter 1: “Introduction” generally introduces the subject area interest with defined problems, research questions, research objectives, and sources of information to be collected for the research. Chapter 2: “Literature Review” summarizes concepts and theories relating to debts, profitability and the relationship between them. From such reviews, basic theories for studying will be synthesized to develop an initial research model and hypotheses used for the research. Chapter 3: “Research Methodology” introduces the approach method of this research through four sub-sessions including research design, variables definition, samples collection and method of data analysis. Chapter 4: “Empirical Results & Discussion” reports the analysis results and meaningful figures. Chapter 5: “Implications & Conclusions” discusses the implications of the results and findings in session four, limitations are also drawn; based on which conclusions and recommendations are provided. Some appendix for detailed outputs from SPSS will be put at last papers for references. [...]... Mbus 1 29 of 44 Debts & Profitability: An examination of manufacturing firms listed in Vietnam CHAPTER 5: IMPLICATIONS & CONCLUSIONS This research assesses the impact of debts on profitability of manufacturing firms in Vietnamese through financials from 200 selected firms listed on Vietnam Stock Exchange Methods of data collection, data analysis and results have been elaborated in Chapter 3 and 4 This... net profit ratio) except return on capital employed and return on investment (ROI) By Truong Hanh Duyen – Mbus 1 15 of 44 Debts & Profitability: An examination of manufacturing firms listed in Vietnam Pratheepkanth (2011) tested the relationship of capital structure (ratios of debt and equity over fund) with financial performance of firms listed on Sri Lanka Stock Exchange from 2005 – 2009, indicated... Profitability: An examination of manufacturing firms listed in Vietnam return on equity and net margin of manufacturing firms listed on Vietnam Stock Exchange This research was limited to the analysis to manufacturing companies given the important role of this sector in the economy In addition, firm in same sector have homogeneity in terms of financial structure In this aim, the population of the study.. .Debts & Profitability: An examination of manufacturing firms listed in Vietnam CHAPTER 2: LITERATURE REVIEW In this chapter, theoretical background and review on previous studies are presented, including 5 sections The first and second section is some popular definitions of debts and profitability The third presents the relationship of debts and profitability The forth is theoretical... decisions to control and reduce bankruptcy costs By Truong Hanh Duyen – Mbus 1 32 of 44 Debts & Profitability: An examination of manufacturing firms listed in Vietnam References Abor, J (2005) The effect of capital structure on profitability: an empirical analysis of listed firms in Ghana Journal of Risk Finance, 6(5), 438-445 http://dx.doi.org/10.1108/15265940510633505 Abor, J (2007) Debt policy and. .. Impact of Financial Leverage to Profitability Study of Non-Financial Companies Listed in Indonesia Stock Exchange European Journal of Economics, Finance and Administrative Sciences, 32, 137 – 48 Brabete, V., & Balasundaram, N (2010) Capital Structure and its impact on profitability: a study of listed manufacturing companies in Sri Lanka Young Economists' Journal, 15, 7-16 Ebaid, E (2009) The impact of. .. debts, and it is consistent with the prediction of the output maximization hypothesis Valeriu and Nimalathasan (2010) pointed out capital structure and its impact on profitability: a study of listed manufacturing companies in Sri Lanka The result shows that debt to equity ratio is positively and strongly associated to all profitability ratios (gross profit ratio; operating profit ratio; and net profit... weak positive relationship between gross profit and capital structure and at the same time, there is a negative relationship between net profit and capital structure Luper and Isaac (2012) examined the impact of capital structure on the performance of manufacturing companies in Nigeria The annual financial statements of 15 manufacturing companies listed on the Nigerian Stock Exchange were used for this... Harjanti and Tandelilin (2007), Valeriu and Nimalathasan (2010), Luper and Isaac (2012) 5.2 Limitation: Although this research was carefully prepared, I am still aware of its limitations and shortcomings The research was conducted in a limited population of 200 manufacturing firms listed on Vietnam Stock Exchange It would be better if it was done in a larger sample including not only listed but also non -listed. .. impact of the various debts on the firm performance By Truong Hanh Duyen – Mbus 1 16 of 44 Debts & Profitability: An examination of manufacturing firms listed in Vietnam A study of Nima, Mohammad, Saeed, & Zeinab (2012) examined the relationship between capital structure and firm performance of Tehran Stock Exchange Companies is investigated between the years 2006 to 2011 The study uses three performance . Harjanti and Tandelilin (2007) to all manufacturing companies listed in Jakarta Stock Exchange from 2000 to 2004 indicated that profitability Debts & Profitability: An examination of manufacturing. proportion of equity and debt the Debts & Profitability: An examination of manufacturing firms listed in Vietnam By Truong Hanh Duyen – Mbus 1 12 of 44 company is using to finance its. UNIVERSITY OF ECONOMICS HO CHI MINH CITY International School of Business TRUONG HANH DUYEN DEBTS AND PROFITABILITY AN EXAMINATION OF MANUFACTURING FIRMS LISTED ON VIETNAM