UNIVERSITY OF ECONOMICS HO CHI MINH CITY ERASMUS UNIVERSITY ROTTERDAM INSTITUTE OF SOCIAL STUDIES VIETNAM THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS CORPORATE INCOME TAXES AND FIRMS’ FINANCING DECISIONS: THE CASE OF VIETNAMESE TAX INCENTIVES BY PHAM NGUYEN QUANG HOA MASTER OF ARTS IN DEVELOPMENT ECONOMICS HO CHI MINH CITY, DECEMBER 2017 UNIVERSITY OF ECONOMICS HO CHI MINH CITY ERASMUS UNIVERSITY ROTTERDAM INSTITUTE OF SOCIAL STUDIES VIETNAM THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS CORPORATE INCOME TAXES AND FIRMS’ FINANCING DECISIONS: THE CASE OF VIETNAMESE TAX INCENTIVES A thesis is submitted in partial fulfilment of the requirement for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS BY PHAM NGUYEN QUANG HOA ACADEMIC SUPERVISOR Prof Dr NGUYEN TRONG HOAI HO CHI MINH CITY, December 2017 CERTIFICATION This is to certify that this thesis entitled “Taxes and Corporate Financial Decisions: The Case of Vietnamese Tax Incentives”, which is submitted by me in fulfillment of the requirements for the degree of Master of Art in Development Economics to Viet Nam – The Netherlands Programme (VNP) To the best of my knowledge, my thesis does not infringe on anyone’s copyright nor violate any proprietary rights and that any ideas, techniques, quotation, or any other material from the work of other researchers in my thesis, published or otherwise, are fully acknowledge in accordance with the standard referencing practices PHAM NGUYEN QUANG HOA ACKNOWLEDGEMENT I would like to thank my supervisor, Dr Nguyen Trong Hoai for his comprehensive guidance, great support and valuable advice he has given through my research study I have been very lucky to a supervisor who took a high cared about my work and who respond to my question He consistently allowed this paper to be my work but steered me in the right the direction whenever he thought I needed it His careful editing contributed enormously to the production of this thesis I also would like to thank my co-supervisor Dr Truong Dang Thuy for his enthusiastic support, availability and constructive suggestion, which help me overcome the challenge and high-pressured situation during the time of research I would like to express my gratitude to all lecturers of the Vietnam- Netherlands Program who have provided an interesting lesson to build my economic knowledge during this program Besides, completing this work would have been difficult if it is not supported by my best friends I am indebted to them for their help Moreover, I wish to thank all my friends who are in VNP 21 who share unforgettable memories in this program Finally, there are also words of deep gratitude for my family who support and encourage me when I implement my postgraduate studies Pham Nguyen Quang Hoa December, 2017 ABSTRACT Based on the tax incentives policy enacted by Vietnamese Government in the year 2004, this paper applies Difference in Difference method and compares the debt- equity ratio of treatment and un-treatment (control) companies before and after this policy to determine the impact of corporate taxes’ change on firm’s capital structure The treatment group is state enterprises and otherwise is control group The data is collected in the period from 2001 to 2007, therein data related to the period 2001- 2003 is pre-treatment data and those in the period 2004-2007 is post- treatment date Similar to prior capital’s literature, the empirical results expose that that taxation actually has impact on leverage The measured impact is approximately -4.1 percentage point, meaning that with the introduction of incentive tax policy, the debt ratio of companies reduces more than percentage point The evidences also indicate that the large companies absorb the effect of tax change more than Small and Medium Enterprises and also are high significant level LIST OF TABLES Table 1: Variables’ definitions and measurement 23 Table 2: Descriptive Statistics and Means Differences for the period 2001-2007 28 Table 3: Descriptive Statistics and Means Differences for the year 2003 29 Table 4: Impact of Taxation on Company’s Capital Structure 34 Table 5: Small and Medium Enterprises versus Large Companies .36 LIST OF FIGURES Figure 1: The mechanism of the relationship between taxes change and financial structure 18 Figure 12: The difference between two groups after exogenous event .22 Figure 3: Common trend over time Figure 3- Panel A: Leverage 30 Figure 3- Panel B: Assets .30 Figure 3- Panel C: Labor 46 Figure 3- Panel D: Liquidity Ratio 46 Figure 3- Panel E: Investment 47 Figure 3- Panel F: Tangibility 47 Figure 3- Panel G: Profitability 48 Figure 3- Panel H: ROE .48 Figure 3- Panel I: Profit Margin 49 Figure 3- Panel K: Inventories Turnover .49 Figure 4- Bivariate Analysis Figure 4- Panel A: Leverage- Assets 50 Figure 4- Panel B: Leverage- Labor 51 Figure 4- Panel C: Leverage- Liquidity Ratio 52 Figure 4- Panel D: Leverage- Investment 53 Figure 4- Panel E: Leverage- Tangibility 54 Figure 4- Panel F: Leverage- Profitability 55 Figure 4- Panel G: Leverage- ROE 56 Figure 4- Panel H: Leverage- Profit Margin 57 Figure 4- Panel I: Leverage- Inventories Turnover .58 Formatted: Font: Not Bold, Font color: Auto LIST OF APPENDICES ANNPENDIX A1: FIXED EFFECT TEST .59 ANNPENDIX A2: RANDOM EFFECT TEST 60 ANNPENDIX A3: HAUSMAN TEST 61 CONTENS CHAPTER INTRODUCTION 10 1.1 Problem statement 10 1.2 Research objectives 12 1.3 Organization of the study 12 CHAPTER LITERATURE REVIEW 14 2.1 Tax changes 14 2.1.1 Tax changes are observed over a long period 14 2.1.2 Tax change is considered as an exogenous event 15 2.2 Measurements of capital structure and several elements have impact on capital structure 17 2.2.1 Measurements of cCapital structure 17 2.2.2 The impact of several elements on capital structure 18 2.3 Two main methodologies and empirical results regarding the effect of tax changes on capital structure’s decision in prior researches 21 2.3.1 Two main methodologies in prior researches 21 2.3.2 Empirical results in prior researches’ summary 22 2.4 Chapter remark 24 CHAPTER 3: DATA AND METHODOLOGY 27 3.1 Data source 27 3.2 Empirical model 28 CHAPTER 4: RESULTS AND DISCUSSION 34 4.1 Descriptive statistics 34 4.2 Bivariate analysis 36 4.3 Regression results 42 4.3.1 Impact of Corporate Tax Incentives on firms’ capital structure 42 4.3.2 Impact on Small and Medium Enterprises versus Large Companies 45 4.3.3 Discussion of research results 47 CHAPTER 5: CONCLUSION AND POLICY IMPLICATIONS 50 5.1 Conclusion 50 5.2 Policy implications 51 5.3 Limitation of the study 52 REFERENCES 54 ANNPENDIX 72 CHAPTER INTRODUCTION 1.1 Problem statement If a business has used debt in its capital structure and the amount of the debt within the permitted level that the lenders cannot demand a higher interest rate, it will take advantage from the debt tax shield Since the cost of lending (proxied by interest) is deducted before calculating taxable profits, reduce profits, thereby, reduces the corporation tax of income that businesses must pay Some studies found the empirical evidences to support that taxes effect on capital structure However, it exists not less debates around this theory From the very first days of capital theories, Modigliani and Miller (1958), Miller (1977) and DeAngelo and Masulis (1980) desired to measure the impact of debt tax shield on corporate financial decisions They found the evidences suggesting that the more companies use debt to finance business, the more their own capital structures change related to tax benefit To the recent papers (Panier, Perez-Gonzales, and Villanueva, 2012; Princen, 2012; Faccio, Xu, 2015; …), these authors supply empirical results that tax benefit from debt tax shield effects firms’ leverage Princen (2012) used Difference in Difference model for the period 2001- 2007 to present that an equal tax treatment between debt and equity encouraging companies to use 2-7 percent less debt than a traditional tax system Panier, Perez-Gonzales and Villanueva (2012) approached in another aspect that is the equity ratio (the ratio between equity value and total assets) and showed the equity ratio of Belgium firms substantially rising from 32.6 percent in 2004 and 2005 to 34.2 percent in two following years In this case, 2004 is the year the tax reform had been valid Vietnamese corporate tax rules can be considered as a traditional tax system (Graham, 2003) Companies are taxed on their profits (the business income less the costs to generate that income) Those business that related costs included in the interest paid as return to the creditors Since these interest expenses reduces taxation income (tax deductibility) However, the returns to shareholders or 10 Figure 32- Panel E: Investment Trend over time of Investment 1,2 0,8 0,6 0,4 0,2 2001 2002 2003 2004 treatment 2005 2006 2007 control Figure 32- Panel F: Tangibility Trend over time of Tangibility 1,2 0,8 0,6 0,4 0,2 2001 2002 2003 2004 treatment 60 2005 control 2006 2007 Figure 32- Panel G: Profitability Trend over time of profitability 0,05 0,045 0,04 0,035 0,03 0,025 2001 2002 2003 2004 treatment 2005 2006 2007 control Formatted: Line spacing: Multiple 1,08 li Figure 32- Panel H: ROE Trend over time of ROE 0,2 0,15 0,1 0,05 -0,05 -0,1 2001 2002 2003 2004 treatment 2005 2006 2007 control Formatted: Line spacing: Multiple 1,08 li 61 Figure 32- Panel I: Profit Margin Trend over time of Profit Margin 0,04 0,035 0,03 0,025 0,02 0,015 0,01 0,005 Fig 2001 ur 2002 2003 2004 treatment 2005 2006 2007 control Trend over time of Inventories Turnover 140 120 100 80 60 40 20 2001 2002 2003 2004 treatment 2005 2006 2007 control e 32- Panel K: Inventories Turnover Panel I: Profit Margin Panel K: Inventories Turnover 62 Formatted: Line spacing: Multiple 1,08 li Formatted: Line spacing: Multiple 1,08 li Figure 43: Bivariate Analysis Panel A: Leverage- Assets 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 treatment untreatment 0,4 0,3 Figure 0,2 43- 0,1 Panel 0,0 B: 500000 1000000 1500000 2000000 ASSETS Levera 63 2500000 3000000 3500000 4000000 ge- Labor 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 treatment untreatment 0,4 0,3 0,2 0,1 0,0 1000 2000 3000 4000 5000 LABOR 64 6000 7000 8000 9000 10000 Figure 43- Panel C: Leverage- Liquidity 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 TREATMENT UNTREATMENT 0,4 0,3 0,2 0,1 0,0 0,00 1,00 LIQUIDITY RATIO 65 Figure 43- Panel D: Leverage- Investment Figure 43- Panel E: Leverage- Tangibility 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 TREATMENT UNTREATMENT 0,4 0,3 0,2 0,1 0,0 -1 INVESTMENT 66 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 TREATMENT 0,4 UNTREATMENT 0,3 0,2 0,1 0,0 0,0 0,1 0,2 0,3 0,4 0,5 0,6 TANGIBILITY Figure 43- Panel F: Leverage- Profitability 67 0,7 0,8 0,9 1,0 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 TREATMENT UNTREATMENT 0,4 0,3 0,2 0,1 0,0 -0,4 -0,2 0,0 0,2 0,4 PROFITABILITY 68 0,6 0,8 1,0 Figure 43- Panel G: Leverage- ROE 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 TREATMENT UNTREATMENT 0,4 0,3 0,2 0,1 0,0 -1,0 -0,5 0,0 0,5 1,0 ROE 69 1,5 2,0 2,5 3,0 Figure 43- Panel H: Leverage- Profit Margin 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 TREATMENT UNTREATMENT 0,4 0,3 0,2 0,1 0,0 -0,5 -0,4 -0,3 -0,2 -0,1 0,0 0,1 PROFIT MARGIN 70 0,2 0,3 0,4 0,5 Figure 43- Panel I: Leverage- Inventories Turnover 1,0 0,9 0,8 0,7 LEVERAGE 0,6 0,5 TREATMENT UNTREATMENT 0,4 0,3 0,2 0,1 0,0 0,0 10,0 20,0 30,0 40,0 50,0 60,0 INVENTORIES TURNOVER 71 70,0 80,0 90,0 100,0 ANNPENDIX ANNPENDIX A1: FIXED EFFECT TEST Fixed-effects (within) regression Group variable: madn Number of obs Number of groups = = 6370 910 R-sq: Obs per group: = avg = max = 7.0 within = 0.1459 between = 0.1962 overall = 0.1778 corr(u_i, Xb) F(15,5445) Prob > F = -0.2565 leverage Coef t se tax lassets labor investment tangibility profitability roe profit_margin inventories_turnover current_ratio liquidity_ratio nol inflation gdp_growth _cons -.0236555 -.0167051 1070567 -.0000665 0002182 -.0768432 -.173023 0005826 -.0661074 0000129 -.0001878 -.0007117 -.0040991 -.0010048 -.217154 -.3300456 sigma_u sigma_e rho 21649976 14239763 69802955 F test that all u_i=0: Std Err .005617 (omitted) 0083928 0046224 0000129 0001726 0120636 0364512 0035993 0233479 7.60e-06 0002102 0002869 0068176 0016876 1167908 0400694 t P>|t| = = 62.03 0.0000 [95% Conf Interval] -4.21 0.000 -.0346671 -.012644 -1.99 23.16 -5.14 1.26 -6.37 -4.75 0.16 -2.83 1.69 -0.89 -2.48 -0.60 -0.60 -1.86 -8.24 0.047 0.000 0.000 0.206 0.000 0.000 0.871 0.005 0.091 0.372 0.013 0.548 0.552 0.063 0.000 -.0331583 097995 -.0000919 -.0001201 -.1004928 -.2444818 -.0064735 -.1118785 -2.04e-06 -.0006 -.0012741 -.0174644 -.0043133 -.4461107 -.4085976 -.000252 1161185 -.0000412 0005565 -.0531936 -.1015641 0076387 -.0203362 0000277 0002244 -.0001492 0092662 0023036 0118027 -.2514936 (fraction of variance due to u_i) F(909, 5445) = 72 12.31 Prob > F = 0.0000 ANNPENDIX A2: RANDOM EFFECT TEST Random-effects GLS regression Group variable: madn Number of obs Number of groups = = 6370 910 R-sq: Obs per group: = avg = max = 7.0 within = 0.1366 between = 0.2656 overall = 0.2304 corr(u_i, X) Wald chi2(16) Prob > chi2 = (assumed) = = leverage Coef t se tax lassets labor investment tangibility profitability roe profit_margin inventories_turnover current_ratio liquidity_ratio nol inflation gdp_growth _cons -.018974 -.0528073 -.024789 0809059 -.0000454 0003902 -.1311467 -.2666394 003079 -.0645826 0000119 -.0001493 -.0008793 -.0098363 -.0017682 -.1235409 -.0711984 0057018 0161226 0085794 0034189 0000103 0001752 0112144 0359481 0036559 0234401 7.69e-06 0002091 0002826 0068356 0017256 1191621 0294408 sigma_u sigma_e rho 16710189 14239763 57931472 (fraction of variance due to u_i) Std Err 73 z -3.33 -3.28 -2.89 23.66 -4.41 2.23 -11.69 -7.42 0.84 -2.76 1.54 -0.71 -3.11 -1.44 -1.02 -1.04 -2.42 P>|z| 0.001 0.001 0.004 0.000 0.000 0.026 0.000 0.000 0.400 0.006 0.123 0.475 0.002 0.150 0.306 0.300 0.016 1232.00 0.0000 [95% Conf Interval] -.0301493 -.0844071 -.0416044 074205 -.0000655 0000468 -.1531264 -.3370964 -.0040865 -.1105244 -3.22e-06 -.0005592 -.0014333 -.0232337 -.0051504 -.3570943 -.1289013 -.0077986 -.0212076 -.0079736 0876067 -.0000252 0007336 -.1091669 -.1961825 0102445 -.0186407 0000269 0002606 -.0003254 0035612 0016139 1100125 -.0134954 ANNPENDIX A3: HAUSMAN TEST Coefficients (b) (B) fixed random t tax lassets labor investment tangibility profitabil~y roe profit_mar~n inventorie~r current_ra~o liquidity_~o nol inflation gdp_growth -.0236555 -.0167051 1070567 -.0000665 0002182 -.0768432 -.173023 0005826 -.0661074 0000129 -.0001878 -.0007117 -.0040991 -.0010048 -.217154 -.018974 -.024789 0809059 -.0000454 0003902 -.1311467 -.2666394 003079 -.0645826 0000119 -.0001493 -.0008793 -.0098363 -.0017682 -.1235409 (b-B) Difference sqrt(diag(V_b-V_B)) S.E -.0046816 0080839 0261509 -.0000212 -.000172 0543035 0936165 -.0024964 -.0015248 1.00e-06 -.0000385 0001677 0057372 0007634 -.0936131 003111 7.85e-06 0044463 006035 0000216 0000492 b = consistent under Ho and Ha; obtained from xtreg B = inconsistent under Ha, efficient under Ho; obtained from xtreg Test: Ho: difference in coefficients not systematic chi2(14) = (b-B)'[(V_b-V_B)^(-1)](b-B) = 382.62 Prob>chi2 = 0.0000 (V_b-V_B is not positive definite) 74 ... CORPORATE INCOME TAXES AND FIRMS? ?? FINANCING DECISIONS: THE CASE OF VIETNAMESE TAX INCENTIVES A thesis is submitted in partial fulfilment of the requirement for the degree of MASTER OF ARTS IN DEVELOPMENT... changed the tax regime which lowered the corporate tax rate (reducing the value of tax shields to firms) and cut personal tax rates (Givoly, Hayn, Ofer, and Sarig, 1992) According to Gordon and Jeffrey... series 14 proofs , thus, reducing the risk of a spurious result; solving the problems arising from personal taxes apart appraise the influence of diverse kinds of taxes on firms? ?? leverage; and taking