EXTERNAL FINANCING CHOICE:

THE CASE OF VIETNAMESE LISTED COMPANIES

Nguyen Manh Hiep
Nguyen Thu Hang
Foreign Trade University HCMc Campus, Vietnam
Abstract
We examine the choice of outside financing in Vietnamese listed firms under the trade-off
theory, the pecking order theory and the market timing theory of capital structure pre-crisis and
post-crisis. The results show that market timing theory well explains firms financing choice
when the market is booming. Its explanatory power deteriorates post-crisis, when the market
slows down. The other two theories fail in pre-crisis period but to a certain extent can describe
the external financing choice in post-crisis period. Additionally, we find that firms with higher
level of state ownership tend to use more debts.
Key words: debt, stock issue, state ownership, crisis
I.

Introduction
Companies may raise fund internally by retaining earnings or externally by debt and stock

issue in order to finance investments. The decisions of how to raise fund determine the
companies risk and cost of capital, which in turn affect the investors decisions. The mechanism
through which capital structure determines shareholdersvalue has been extensively researched.
While discussions of capital structure often begin with Modigliani and Miller (1958), who assert
the irrelevance of capital structure in a perfect capital market, other approaches maintain that
capital structure does affect shareholders value. Bradley, Jarrell and Kim (1984) develop the
trade-off theory which incorporates inverse relationship between expected costs of financial
distress and optimal firm leverage. According to this theory, firms will choose the way of
financing so as to move toward the targeted optimal leverage. Myers and Majluf (1984) propose
the pecking order theory, which state that to advoid aversed signaling effect, managers acting in
the interest of existing shareholders prefer debt to equity issue. These two theories are widely
debated and considered to be very descriptive of firms financing decisions. On the other hand,
Baker and Wurgler (2002) have recently attracted great attention by suggesting that capital
structure is simply the outcome of market timing for equity issue.

Our sample data indicates that Vietnamese listed firms investments and dividends are
financed mainly by external sources, of which stock issues and debts account for 18% and 45%
respectively, for a total of 64% on average. That outside financing is so important motivates us to
look for an explanation of how firms choose between stock issues and debts. We examine
external financing decisions by testing the relevance of the trade-off theory, the pecking order
theory and the market timing theory in the case of Vietnamese market using the model as inspired
by Fama and French (2012). Thus, the hypotheses that we are testing in this paper are as follows.
H1: Firms prefer debt to equity issue (the pecking order theory).
H2: Firms attempt to drive leverage to the optimal level (the trade-off theory).
H3: Firms with high share prices tend to issue more equity (the market timing theory).
In Vietnam, there is high level of government participation in the economy. We can see
from Figure 2 that on average the government has almost 32% ownership in listed firms in 2007.
High level of government ownership may heavily affect firms financing decisions. Dewenter and
Maltesta (2001) report greater leverage in government firms in comparison to private firms.
Therefore, our forth hypothesis is as follows:
H4: Fims with higher level of government ownership tends to use more debt.
Besides, due to global financial crisis in 2008, firms financing decision as well as the
banking lending decisions may deviate largely from normal circumstance. To advoid the
distorting effects of financial crisis we divide the data into sub-samples to examine firms
behaviors pre-crisis and post-crisis. Our fifth hypothesis is:
H5: Firms financing decisions in the aftermath of 2008s financial crisis are different
from before.
This paper contributes to the capital structure liturature with new insights into financing
decisions of firms in an emerging market like Vietnam. We go further into analyzing the
influence of state ownership to financing decisions in companies. Moreover, we give an idea of
how corporate financial decisions have changed after the 2008s crisis.
II.

Liturature Review
Previous researches about capital structure focus on two different approaches: the trade-off

theory and the pecking order theory. According to the trade-off theory, firms try to identify their

optimal capital structure, at which the marginal cost of an incremental unit of debt equals its
marginal benefit, and the cost of capital is minimized. The costs of debt include expected
financial distress costs (bankruptcy costs and agency costs). The benefits of debt include tax
shield, agency benefit. DeAngelo and Masulis (1980) and Bradley et al. (1984) are two of the
earliest formal discussions of the inverse relationship between optimal leverage and financial
distress costs.
Myers and Majluf (1984) and Myers (1984) argue that the use of external capital
communicates signals about the managers attitude to outside investors. Such signals may
negatively affect share prices and override the benefit of external financing. In order to protect
existing shareholders value and minimize signaling effects, firms finance investments according
to the pecking order theory, with retained earnings on the top of the order, then debt, and finally
equity issue as last resort. Contrasting with the trade-off theory, this approach entails no optimal
capital structure. Firms leverage is therefore the cumulative outcome of its investment decisions
and need for external capital.
Fama and French (2002) show that these two theories are consistent in some aspects and
differ in others. The trade-off theory and the pecking order theory both agree that more profitable
firms will pay more dividends, and firms with more investments and growth opportunities pay
fewer dividends, and that larger firms have higher leverage. However, the two theories do
disagree on some issues. The trade-off theory posits that companies with higher profitability or
less investment opportunities (or growth) have higher book leverage, while the pecking order
theory predicts that they should have less leverage. The trade-off theory suggests that firms
gradually adjust its leverage to a targeted optimal level, while the pecking order theory involves
no optimal capital structure.
Empirical evidences confirm the shared predictions of these two theories (Fama and
French, 2002), but are inconclusive about which describes reality better. Contrary to the
perspective of the pecking order theory, Frank and Goyal (2000) shows that debt financing does
not dominate equity issues, and that equity issues track financing deficit more closely than debt.
Frank and Goyal (2000) also show mean reversion of leverage as predicted by the trade-off
theory. Nevertheless, Fama and French (2002) show negative relationship between profitability
and book leverage. This evidence strongly supports the pecking order theory and is against the
trade-off theory. Shyam-Sunder and Myers (1999) strongly support the pecking order theory and

posit that mean reversion of leverage is actually the spurious result of cyclicality or mean
reversion in operation and investment activities.
In addition, other researches point out the influence of market factors to a firms financial
decitions. Banker and Wurgler (2002) put forward the market timing theory. Firms issue more
equity when share price is high or cost of equity is low relative to the cost of debt, so there is a
positive relationship between equity issues and market-to-book ratio. The effect of market-tobook to capital structure is observed to be not temporary but very long run, suggesting that firms
leverage is simply the outcome of past attempts to time the equity market. Recent researches have
shown evidence supporting this idea. DeAngelo, DeAngelo and Stulz (2010) show that market
timing opportunities significantly influence the probability of equity issues. This theory entails no
optimal capital structure or order of financing choice.
There are also empirical researches on the relationships between leverage and profitability,
between leverage and growth for Vietnamese firms. For the sample of Vietnamese small and
medium companies, Tran and Ramachandran (2006) observe negative relationship between
leverage and profitability, and positive relationship between leverage and growth. Doan (2010)
shows the same results for listed companies. Okuda and Lai (2012) again show the negative
relationship between leverage and profitability. These appear to support the pecking order theory.
III.
1.

Data and Model

Data
This paper uses a sample of 632 companies listed on Hochiminh Stock Exchange (284

companies) and Hanoi Stock Exchange (348 companies) from 2006-2012. Financial statement
data is provided by iTrade Corporation. State ownership data is provided by Tai Viet
Corporation. Events calendar of dividend payment is acquired from Stockbiz Investment Ltd. The
variables used in this paper and their calculations are listed in Figure 1. To reduce the impact of
outliers, the sample is trimmed by dropping observations that have dAt<-0.5 or dAt>2, Yt<-0.5 or
Yt>0.5, P/Bt-1<0 or P/Bt-1>30. These limits are chosen arbitrarily.

Figure 1: List of variables

Variable

Explanation

dAt

Change in total assets during year t divided by total assets at the end of year t-1.

dLt

Change in total liabilities during year t divided by total assets at the end of year t-1.

dSt

Net equity issued. dSt = dAt + Dt - dLt - Yt

Yt

Net income during year t divided by total assets at the end of year t-1.

Dt

Dividends per share by ex-dividend day adjusted for stock dividends, times number
of shares at the end of year t, divided by total assets at the end of year t-1.

P/Bt-1

Market equity at the end of year t- 1 divided by book equity at the end of year t-1.

LSt-1

Lagged leverage surplus: firms leverage ratio minus industrys leverage ratio at the
end of year t-1. Firms leverage ratio equals total liabilities divided by total assets.
Industrys leverage ratio equal total liabilities of all firms in the industry divided by
total assets of all firms in the industry. Each firm is sorted to one of elevent
different industries as defined by Hanoi Stock Exchange Standard Industry
Classification (excluded financial firms).

Stateownt Percentage of state ownership at the end of year t.

Yeart

Dummy variable. Yeart = 1 if the year is 2008 to 2012 and Yeart = 0 if the year is
2007.

2.

Model
We utilize the model as in Fama and French (2012). It begins with the following basic

equation:
dSt + dLt = dAt + Dt - Yt

(1)

This equation means that the need for external financing, which is the amount of
investments (i. e. change in total assets) plus dividends minus earnings as on the right handside of
the equation, must be totally covered by the supply of new external financing, which is the
amount of capital from net equity issues and net change in liabilities as on the left handside of the

equation. Split equation (1) by different source of external financing we have a pair of equation
(2) and (3).
dSt = a0s + a1sdAt + a2sYt + a3sDt (2)
dLt = a0l + a1ldAt + a2lYt + a3lDt (3)
Because (2)+(3) must give (1), then we have as+al=0, a1s+a1l=1, a2s+a2l=-1, a3s+a3l=1.
To test our five hypotheses we expand equation (2) and (3) by adding P/Bt-1, LSt-1 and
Stateownt and dummy variable Yeart. Equation (2) and (3) become (4) and (5).
dSt = a0s + b0sYeart +(a1s + b1sYeart)dAt + (a2s + b2sYeart)Yt + (a3s + b3sYeart)Dt
+ (a4s + b4sYeart)P/Bt-1 + (a5s + b5sYeart)LSt-1 + (a6s + b6sYeart)Stateownt + est
dLt = a0l + b0sYeart + (a1l + b1lYeart)dAt + (a2l + b2lYeart)Yt + (a3l + b3lYeart)Dt
+ (a4l + b4lYeart)P/Bt-1 + (a0l + b5lYeart)LSt-1 + (a6l + b6lYeart)Stateownt + elt

(4)
(5)

According to equation (1), the sum of regression (4) and (5) must reduce to dAt + Dt - Yt.
That means a1s+a1l=1, a2s+a2l=-1, a3s+a3l=1, and sum of intercepts and slopes of other independent
variables must be 0. The slopes for dAt, Yt and Dt indicate the average proportion of external
financing needed for changes in these variables. Specifically, when Yeart=0, one unit increase in
investments (dAt) required, on average, a1s unit of new share issues and a1l unit of new debt, and
a1s+a1l=1. When Yeart=0, one unit increase in investments (Dt) required, on average, a3s unit of
new share issues and a3l unit of new debt, and a3s+a3l=1. When Yeart=0, one unit increase in Yt
reduces the need for new share issues by a2s and reduce the need for new debt by a2l, and a2s+
a2l=-1. Other paired coefficients show how the splits between debts and share issues may deviate
from average due to the effect of other variables, and each pair must sum to zero.
Pecking order theory posits that external financing is primarily debt. If the theory holds
true (i.e. our first hypothesis H1), variations in dAt, Yt, Dt should be absorbed primarily by the
change in debts. Thus, the absolute values of regression coefficients on dAt, Dt, and Yt from
equation (5) should be higher than in equation (4).
In the trade-off theory, firms identify their optimal capital structure and leverage tends to
move to a targeted level. The higher the leverage surplus, the more firms use share issues instead
of debt. We assume that industry average leverage is the firms target. The slope for LSt-1 should
be positive in regression (4) and negative in regression (5) for hypothesis H 2 (the trade-off
theory) to be accepted.

Variable P/Bt-1, as an indicator of share valuation, is added to test the market timing theory
(hypothesis H3). For the market timing theory to be accepted, firms should issue more shares and
less debt when P/Bt-1 is high. Thus, we predict a positive coefficient of P/Bt-1 in regression (4) and
a negative one in equation (5).
We predict that the higher the proportion of state ownership, the more likely is the use of
debt. That means the slope for this variable should be negative in regression (4) and positive in
regression (5).
To test whether the financial crisis affects firms financial decisions, we add dummy
variable Yeart. Yeart equals 0 for pre-crisis observations (i.e. before 2008), and equals 1 for postcrisis observations. We specify equation (4) and (5) to check if there are differences in regression
slopes between two periods.
To control for other factors that may influence financing choice, we added other variables
as well, for example, market capitalization, ownership structure, board size whose slopes are
not significantly different from zero. Hence, we donot include them in our results that follow.
IV.
1.

Results
Descriptic Statistics
A summary of variable statistics is presented in Figure 2 for two periods: 2006-2007 (pre-

crisis) and 2008-2012 (post-crisis). Price-to-book decreases from an average of 4.894 to 2.729.
This is in line with the crash in the stock market in 2008. Mean income (Yt) is much lower in the
second period (7%, compared to 12.7% in the first period). On average, annual net investments
(dAt) decreases significantly from 42.6% of previous year total assets pre-crisis to only 15% postcrisis. Dividends also decrease after 2008 by a smaller percentage. These changes indicate how
the crisis severely affected firms investment decisions and profitability. Due to large reduction in
financing needs, share issues and debt are much lower post-crisis, but to different extents. While
net liabilities over previous year total assets declines by only 5.3%, net share issued decrease by
almost 17%. Looking at the relationship between use of fund and source of fund, there seems to
be a preference for share issues in the first period, which suddenly move to a preference for debts
in the second period. On average, net share issues finances for nearly 42% of all use of fund
(investments and dividends) pre-crisis, but only 14% post-crisis. These statistics apparently show
serious move in financing decisions after the crisis hit the country.

Figure 2: Summary of statistics

Variable
dSt
dLt
dAt
Yt
Dt
P/Bt-1
LSt-1
Stateownt

Mean Std. Dev. Min

Max
Mean Std. Dev. Min
Max
Period 2006-2007
Period 2008-2012
0.195
0.322 -0.107 1.340 0.026
0.120 -0.464 1.357
0.143
0.334 -0.577 1.827 0.090
0.227 -0.491 1.711
0.426
0.443 -0.384 1.957 0.150
0.278 -0.493 1.884
0.127
0.076 -0.057 0.375 0.070
0.092 -0.321 0.499
0.040
0.041 0.000 0.247 0.036
0.044 0.000 0.498
4.894
3.625 1.200 24.500 2.729
2.873 0.190 29.400
-0.074
0.203 -0.680 0.375 -0.073
0.210 -0.655 0.448
0.319
0.213 0.000 0.791 0.253
0.235 0.000 0.830

From the first to the second period, state ownership decreases from a mean of 31.9% to
25.3%. This may be an indication of the move toward equitization of state-own enterprises, or of
the increasing importance of private sector on the listed markets.
Figure 3 presents correlations of variables. While dAt is highly correlated with dSt and dLt,
the correlations between Yt and dSt, between Yt and dLt are much lower. High correlation
between Dt and Yt suggests that more profitable firms pay more dividends. The correlation
between dAt and dLt is uniquely high, suggesting that growth is financed primarily with debts.
Figure 3: Correlation and covariance matrix
dSt
dLt
dAt
Yt
Dt
P/Bt-1 LSt-1 Stateownt
1
dSt
0.034
1
dLt
0.526 0.832
1
dAt
0.070 0.122 0.346
1
Yt
0.166 0.028 0.125 0.561
1
Dt
0.174 0.082 0.223 0.329 0.178
1
P/Bt-1
0.067 0.022 0.008 -0.300 -0.312 -0.041
1
LSt-1
-0.071
-0.028
-0.036
0.113
0.082
0.032
0.117
1
Stateownt
2.

Regression Results
We do a pooled OLS regression with our firm-year panel data for equation (4) and (5).

The results are presented in Figure 4. T-statistics are calculated with robust standard errors to
increase reliability of t-test.

2.1. Hypothesis H1: Firms prefer debts to equity issues (the pecking order theory)
The pecking order theory posits that variations in investments, dividends and earnings
should be absorbed mainly by the change in debts. Regression slopes of dAt in the first period
(a1s) and in the second period (a1s + b1s) are much lower in equation (4) (0.415 and 0.225) than in
equation (5) (0.585 and 0.775). In economic term, to finance investments, the splits between new
share issues and debts are 41.5% and 58.5% in the first period, 22.5% and 0.775% in the second
period. This means in both periods, Vietnamese listed firms prefer debt to equity issues as the
primary source of external financing to finance investments. Moreover, firms show higher
preference in the second period, with the percentage of share issues decrease by 19% (and
percentage of debt increase by 19% simultaneously). This is in favor of the pecking order theory,
especially in the second period.
Figure 4: Regression results
dSt = a0s + b0sYeart +(a1s + b1sYeart)dAt + (a2s + b2sYeart)Yt + (a3s + b3sYeart)Dt
+ (a4s + b4sYeart)P/Bt-1 + (a5s + b5sYeart)LSt-1 + (a6s + b6sYeart)Stateownt + est
(4)
dLt = a0l + b0sYeart + (a1l + b1lYeart)dAt + (a2l + b2lYeart)Yt + (a3l + b3lYeart)Dt
+ (a4l + b4lYeart)P/Bt-1 + (a0l + b5lYeart)LSt-1 + (a6l + b6lYeart)Stateownt + elt
(5)
Dependent variable
dSt Equation (4)
dLt Equation (5)
2072
2072
No. of obs.
0.43
0.76
R-squared
Indep. Var.
Coef.
t
ais+bis
Coef.
t
ail+bil
a0s
a0l
0.064
1.310
-0.064
-1.310
Constant
b0s
-0.067
-1.360
b0l
0.067
1.360
Yeart
a1s 0.415*** 5.280
a1l 0.585*** 7.430
dAt
0.225***
0.775***
b1s -0.190** -2.300
b1l 0.190**
2.300
Yeart*dAt
a2s -1.257*** -4.210
a
0.257
0.860
Yt
-0.398*** 2l
-0.602***
b2s 0.859*** 2.820
b2l -0.859*** -2.820
Yeart*Yt
a3s 2.464*** 3.740
a3l -1.464** -2.220
Dt
0.790***
0.210
b3s -1.674** -2.490
b3l 1.674**
2.490
Yeart*Dt
a4s 0.019*** 3.150
a4l -0.019*** -3.150
P/Bt-1
0.002*
-0.002*
b4s -0.017*** -2.800
b4l 0.017*** 2.800
Yeart* P/Bt-1
a5s
0.114
0.880
a5l
-0.114
-0.880
LSt-1
0.049***
-0.049***
b5s
-0.065
-0.500
b5sl
0.065
0.500
Yeart*LSt-1
a6s -0.254** -2.420
a
0.254**
2.420
Stateownt
-0.031*** 6l
0.031***
2.120
b6l -0.223*** -2.120
Yeart*Stateownt b6s 0.223**
*, **, ***: Significant at 90%, 95%, 99% confidence interval

With regard to the coefficient of Yt and Dt, the results are not clear, especially for the first
period. Interestingly, in the first period coefficients of Yt and Dt are abnormally high in regression
(4) and abnormally low in regression (5). This means firms with higher level of dividends
significantly increase net share issues and reduce its net borrowings. In the first period
coefficients of Yt are abnormally high in regression (4) and insignificant in regression (5). This
means less profitable firms issue remarkably more share but do not borrow more. These
interpretations are quite inconsistent with the pecking theory. Nevertheless, the second period
exhibits a completely different trend. Debt financing becomes more important to absorb
variations in dividends and earnings post-crisis. To sum up, given that dAt is dominant in size
compare to Dt and Yt, to some extent the firms probably prefer borrowings to share issues.
This preference of equity issue, to be cautious, doesnt necessarily in favor of the pecking
order theory but may be a consequence of the market institutional characteristics. Rajan and
Zingales (2001) suggest that in countries with underdeveloped financial markets and other
institutions and physical-asset-intensive industries, bank-based systems has an advantage to
market-based system and dominates. Moreover, firms may refrain from equity issues because the
cost and risk of such direct financing are much higher than borrowing from the banking system.
In this limited paper, however, we accept that the statistical results are in favor of the pecking
order theory.
To summarize, the evidence supporting pecking order theory is stronger post-crisis than
pre-crisis. The theory, to some extent, has some explanatory power to firms external financing
choice but is far from a perfect description.
2.2. H2: Firms attempt to drive leverage to the optimal level (the trade-off theory)
If the trade-off theory holds true, the slope of LSt-1 should be positive in regression (4) and
negative in equation (5). In the first period, the slopes of LSt-1 are insignificant, suggesting that
firms dont really care about optimal capital structure. In the post-crisis periods, our predictions
are realized. Firms appear to become interested in optimal leverage. Although the coefficients are
significant different from zero, their absolute values are relatively small. LSt-1 seems to affect
firms financial decision modestly. We see from Figure 2 that one standard deviation of LSt-1 is
0.21. The coefficients of LSt-1 in the second period are 0.049 in equation (4) and -0.049 in
equation (5). If the firm has last year leverage surplus of one standard deviation above zero, it

will on average increase share issues by 1.029% (=0.049*0.21) and reduce borrowing by 1.029%
of previous year assets. The number suggests that the tendency toward optimal leverage seems
very slow. Welch (2004) researches the U.S. market and shows that the tendency to revert
leverage to the target level is mild. Slow adjustment is also found in Hovakimian, Opler, and
Titman (2001), Fama and French (2002), Fama and French (2012).
To conclude, although the trade-off theory can explain firms external financing choice
after the crisis, but the tendency toward targeted leverage is very slow.
2.3.

H3: Firms with high share prices tend to issue more equity (the market timing
theory)
While the pecking order theory and the trade-off theory fail for the first period, the market

timing theory appears to give a good explanation of firms finacing choice. The coefficients are
significant for both periods, but to different extents. The coefficient of P/Bt-1 pre-crisis is as high
as 0.019, which reduces to as minor as 0.002 in post-crisis. Along with this large decrease is the
reduction in statistical significance.
We come to the conclusion that when the market is booming (as of pre-crisis), the market
timing theory can describe firms financing choice very well. The explanatory power of the
theory seems to deteriorate when the market slows down.
2.4.

H4: Fims with higher level of government ownership tends to use more debt.
We predict negative coefficient of Stateownt in regression (4) and positive coefficient in

regression (5). The results are in line with our predictions. We conclude that firms with higher
state ownership will borrow more. However, the coefficients remarkably differ in two periods.
Absolute value of the coefficient in the first period is more than 8 times higher than in the second
periods. It might be that the trend is diminishing. Another explanation, which we think more
persuasive, is that all firms are becoming more favorable to debt financing makes the difference
between low state-owned and highly state-owned firms blurred.
2.5.

H5: Firms financing decisions in the aftermath of 2008s financial crisis are different
from before.
Our regressions show significant cross-effect bij coefficients when Yeart = 1, suggesting

that financing choice has been dramatically changed after the crisis hit the economy. Specifically,

before the crisis, firms financing choice seems to largely depend on market price of equity. After
the crisis, this dependence has significantly reduced, and pecking order theory and trade-off
theory come into place to explain firms financial decisions.
V.

Conclusion
The results are very different in our two sub-periods. We conclude that for our sample of

Vietnamese listed companies from 2006 to 2012, the market timing theory realizes before 2008
when the market is booming, but its explanatory power declines in the aftermath of the financial
crisis. The pecking order theory and the trade-off theory to a certain extent can explain firms
external financing choice post-crisis. For post-crisis period, the pecking order theory seems to be
a good explanation of financing choice for Vietnamese listed firms. The trend to move toward
target leverage as proposed by the trade-off theory, although statistically accepted, is mild.
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