International Review of Business Research Papers

Vol. 11. No. 1. March 2015 Issue. Pp. 114 132

Trade-Off Theory or Pecking Order Theory with a StateOwnership Structure: The Vietnam Case
Sbastien. Dereeper1 and Quoc Dat. Trinh2
The process firms use to choose their capital structures is explained
by different corporate finance theories in which trade-off and pecking
order are the two most popular hypotheses. Testing these two
models will help to determine whether a target debt ratio exists, and
if so, how rapidly firms adjust their current leverage levels to match
this target level. The findings in this paper determined that the
pecking order theory might not be applied in Vietnam when internal
funds and new equity issuance are independent with the leverage
level. In contrast, our empirical results proved that the long-run target
debt ratio does exist in the Vietnamese market. The partialadjustment model has shown that both private firms and state-owned
firms rapidly adjust to their optimal levels of debt. However, the state
ownership structure does not affect the amount of debt taken during
the year by the firms.

Field of Research: capital structure, state-owned firms, private firms, speed adjustment.

1. Introduction
Although being published in stock exchange is an efficient way to raise middle and longterm funds, firms still continue borrowing from financial intermediaries such as banks or
financial companies for many reasons. The conflicts among shareholders and managers of
the firms might be one of those reasons. When raising funds from the stock market, firms
managers need to report business activities to many other new shareholders. This means
they are loosening their control to the firms and they need to disclose more inside
information to public. This is not what managers want because Jensen and Meckling (1976),
with the concept of separation of ownership and control, indicated that managers can be
more interested in transferring firms resources into their personal benefits instead of
spending efforts on leading the firms. The decisions made by managers will not totally
maximize firms value as it would be. In contrast, although shareholders do not directly
control and manage firms activities, they do own the firm and receive a fraction of the gain.
Shareholders will need to pay some costs to the managers and establish appropriate
monitoring solutions with the hope that the managers will act for the best benefits of
shareholders.
However, raising funds from banking system also faces many difficulties. These might be
the costs of bankruptcy if firms are out of payment, or other accurate borrowing conditions
issued by the banks that firms must satisfy. Generally, banks approve firms loans based on
their own appraisal processes. However, in emerging market, where the effect of the state
on financial market is quite obviously, the decisions of banking system on how to give loans
to firms might be remarkably affected by the governments policy.
1

Dr. Sbastien. Dereeper, Professeur des Universits, Universit de Lille 2 - SKEMA Business school,
ECCCS research center, sebastien.dereeper@univ-lille2.fr;
2
Quoc Dat, Trinh, Universit de Lille 2 - SKEMA Business school, ECCCS research center,
quocdat.trinh@etu.univ-lille2.fr;

Dereeper & Trinh

La Porta et al. (2002), Dinc (2005) suggested that profit might not be considered as the top
priority concern rather than serving primarily for political purposes of state-owned banks. In
China, Liu et al (2011) found that the influence of government intervention to financing
behaviors is significant and they suggested that state-owned firms would have the chance
to borrow more while non-stated firms would meet difficulty in borrowing.
The economic reform (Doi Moi) policy, started from 1986, has created a great change over
the whole economy of Vietnam from the centrally planned economy into the market oriented
economy. Along with the market mechanisms, applied since Doi Moi, an equitization of
state-owned enterprises was implemented in 1990 and dramatically promoted from 1996. In
the year of 2000, Ho Chi Minh stock exchange was established for the first time in Vietnam,
and five years later, in 2005, Ha Noi stock exchange was established with slightly lower
requirements on equity scale to listed firms. Those events were the steps that the
government executed to bring more efficient and transparent management mechanisms to
all enterprises. However, not all the firms are fully equitized. Government still holds
ownership control in different specific and important-to-nation industries such as energy,
exploitation of natural resources, agriculture and forestry. That leads to the existence of
partly-equitized firms even in the stock market. Therefore, examining the intervention of
Vietnamese government on how firms support their financial needs is necessary.
A study on the effect of state ownership to capital structure of small and medium unlisted
enterprises in Vietnam was conducted by Nguyen (2006). By considering 558 small and
medium unlisted firms, from 1998 to 2001, Nguyen provided a consensus with Liu et al.
(2011) for China case by showing that state-owned small and medium enterprises have
more advantages in accessing bank loans than non state-owned enterprises. Another study,
two years later, in 2008, conducted by Nahum Biger et al., confirmed the relationship
between firms characteristics and capital structure in Vietnam. The leverage ratio is
positively related to firm size, growth opportunities and managerial ownership but it is
negatively correlated with non-debt tax shield, fixed assets and profitability. In 2012, Okuda
and Nhung, investigated the opaque relationship between state-owned firms and
government banks through an empirical analysis of a panel data sample from 2006 to 2009.
These two authors stated that agency cost theory clearly explains the mechanism of debt
choices for enterprises in Vietnam. Companies prefer to use more debt when managerial
ownership ratio is high, and vice versa, lower level of managerial ownership would come
along with lower level of debt. Okuda and Nhung also found similar result with Nguyen
(2006) by suggesting that state-owned companies in average have higher debt ratio than
private companies in both Ho Chi Minh and Hanoi stock market.
Although the relationship between government control and leverage ratio of firms in Vietnam
has been studied by Nguyen (2006), Nahum Biger et al. (2008), Okuda and Nhung (2012),
an empirical test for the application of the two classical models, tradeoff theory or pecking
order theory, the Vietnam case, has not been precisely conducted. In addition, the
confirmation of whether an optimal level of debt exists for Vietnamese firms is questionable.
And if an optimal level of leverage exits, at which speed the firms will adjust current debt
level toward target debt level is also to be concerned. Our study aims to provide a clear
explanation for these issues and together with other researches; we hope our paper will
contribute to clarify the effect of government ownership on firms choices of capital structure
in Vietnam; and answer the question of at which speed firms will adjust their borrowing
behaviors toward the optimal choices to maximize the firm value.

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The paper is organized as follows. The first section is Introduction which aims to set up the
idea of the paper and show how this study is important to Vietnam. The second section is
Literature Review. This section provides a brief summary of what other studies have
suggested about the capital structure theories, both in developed and developing countries.
Section two also reviews the relationship between ownership and debt ratio. Moreover,
section two states three hypotheses which are going to be tested in the paper. The third
section specifies how regression model was built to conduct an empirical test for three
hypotheses stated in section two. Section four explains the variables and shows how the
data were collected. Section five and section six provide our analysis results on the
application of tradeoff theory and pecking order theory in Vietnam market, respectively.
Final section is conclusion and areas for further research.

2. Literature Review
Since the study of Miller and Modigliani (MM) in June 1958, capital structure theory has
been continued studying properly. The trade-off theory, which rejects the irrelevance
preposition by considering imperfect and friction capital market, suggests that a firm should
maximize its value by balancing the costs and benefits of borrowing debts. While costs of
debts are majored as the financial bankrupt cost or distress cost when firms used
extravagant debts and might not be able to meet the deadline of interest and principal
payments, the most significant gain of debt is identified by the debt-tax shield through
interest deduction. The optimal debt level is considered as the intersection between
marginal costs and marginal benefits of using more debts (Myers, 1984). Therefore, static
trade-off theory recommends that a firm should substitute between equity and debt till it
reaches the target ratio to maximize its value. However, in a dynamic world, firm itself
changes overtime. The dynamic tradeoff theory states that optimal debt ratio of the firm is
adjusted by the change of exogenous and endogenous factors.
In contrast, the pecking order theory, which considers the asymmetric information
assumption, predicts that no optimal leverage level is preferred. In fact, firms prefer to use
internal funds to finance for their capital demand before borrowing debts or issuing stock.
The main assumption of the theory, asymmetric information, indicates the costs of adverse
selection. This predicts that firms owners (insiders) normally have more information of the
firms than investors (outsiders). Because of that, if firms issue equity to finance for new
projects, the market might consider those projects as ineffective or high risk projects.
Consequently, equity would be underpriced. New projects are going to be rejected even
they have positive NPV. Leland and Pyle (1977) stated that it could be a signal of low-return
business results if firms decide to sell equity to the outside investors and vice versa. In
addition, management purpose is also another reason that firms are not willing to issue new
stock to call for capital. Kenny Bell and Ed Vos (2009), concluded if given the
unconstrained choice between external debt and internal funds, SMEs will, in general,
choose not to utilise debt due to the preference for independence, control and financial
freedom. Consequently, the pecking order, firstly, starts with internal finance (using
retained earnings and adapting target dividend payout ratio to investment opportunities),
then continues with safe securities such as debt and convertible bonds if internal funds
provide insufficiently. Equity is only chosen as the last resort.
Given the importance of these two theories in capital structure, several empirical tests have
been conducted to examine the application of these theories in practice. The authors who
are supported for perking order theory, such as Shyam-Sunder and Myers (1999), by testing

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a sample of 157 firms in US, has concluded that pecking order theory provides a good firstorder approximation of firm financing behaviors. They concluded that within their sample
and model of testing, the basic pecking order theory explains actual debt ratio much better
in time-serial variance than static trade-off theory. Graham and Harvey (2001) figured out
that the marginal benefits of tax shield seem to be far bigger than the marginal costs of
bankruptcy for almost all the firms. In this case, firms should use more debts (increase
leverage) because they were under-leveraged. Both pecking order theory and trade-off
theory are supported at a given level but not really clear when little evidences are significant
for the choices of debts based on asset substitutions, asymmetric information, transaction
costs and personal taxes. However, J.Qiu and F.Smith (2007), predicted that pecking order
theory might not be the first-order if sample difference and nonlinearity are taken into
account.
For the trade-off theory, the relation between firms features and leverage has been tested
widely among researchers. One of those features is ownership structure. Interesting
relations have been found. Brailsford et al. (2002) figured out that there exists a
demonstration of an association between capital structure and ownership structure.
Particularly, they found a positive relationship between external block-holders and
leverage, a curvilinear relationship between the level of managerial share ownership and
leverage. Low level of managerial ownership will create a fall in agency conflicts, and thus,
bring a higher level of debt in capital structure.
For emerging market such as China and Vietnam, the presence of government on firms
ownership is remarkable. Liu, Tian and Wang (2011) examined a case study with the
sample of over 1000 firms in both state-owned and non state-owned enterprises (SOEs and
non SOEs respectively) in China. They found that SOEs use more debts than non SOEs
and financial behaviors of SOEs are influenced more by the government; whereas non
SOEs are more market-oriented. Jiang and Zeng (2010) also considered the role of state
intervention on debt level of all the listed firms in China from 2000 to 2006. They found that
regarding short-term loans, listed state-owned firms received a better policy of appraisal
from the state-owned banks than private listed firms. In addition, as mentioned in
Introduction section, Nguyen (2006) and Okuda and Nhung (2012) suggested state-owned
companies in average have higher debt ratio than private companies in Vietnam. Therefore,
the first hypothesis tested in the paper is: state-owned listed firms use more debt or have
higher leverage ratio than private listed firms.
In a different study, considering 79 listed firms, Fauzi (2012) tried to investigate the
application of trade-off theory and pecking order theory in New Zealand. He found that
tradeoff theory is more appropriately explained for New Zealand listed firms. However, Qiu
and La (2010) using unbalanced panel data of 367 firms for the period of 15 years,
suggested that pecking order theory is applied for the Australia case. Bruslerie and Latrous
(2007) conducted a detail empirical test on the relationship between ownership structure
and debt leverage. With a sample of 112 listed firms on the French stock market, over the
period from 1998 to 2009, they found a U-shape relationship between shareholders
ownership and leverage. Controlling managers firstly at the low level of ownership prefer to
use more debt to resist the attempted acquisition (takeovers) from outsiders. However,
when the distress costs increases along with the higher level of debt and when the level of
ownership reaches a certain point, controlling shareholders converge into using other
resources to support for business activities rather than debts. These studies bring us the
second hypothesis to test: there exists an optimal level of debt for each firm in accordance

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with its characteristics. This hypothesis aims to prove the application of trade-off theory in
Vietnam.
Other authors used firms characteristics to determine target leverage and considered the
speed that a firm would adjust its leverage level toward the optimum. Leary and Roberts
(2004) concluded that firms, in the presence of adjustment costs, tend to partly adjust their
debt ratios toward the optimal leverage level. Flannery and Rangan (2005), using a huge
US dataset from 1965 to 2001, stated the existence of target debt level and firms partially
moved toward the optimal debt level by the rate of 32% of the gap between current and
target debt ratio each year. From that, we continue to test the third hypothesis: a firm
continuously adjusts its leverage level toward the optimal level for both state-owned and
private listed firm.

3. Regression Model Specification

The paper considers the market debt ratio as total interest-bearing borrowings to the sum of
interest-bearing debts and market value of outstanding common shares.
(1)
The market debt ratio (MDR) is conducted based on the ideas of Flannery and Rangan
(2005) to consider the market capital capacity of the firm. In which,
is defined as
interest-bearing debt of firm i at time t while S i,t indicates the number of common shares
outstanding of firm i. Pi,t denotes the price per share of stock i at time t.
The tradeoff theory states that target leverage ratio might differ overtime and across firms
following firms characteristics. And there always exists an optimal level of debt ratio, which
is specified by the following form:
MDR*i,t+1= Xi,t

(2)

Where MDR*i,t is the desired market debt ratio, is coefficient vector, and X i,t is the vector
set of firms characteristics. The trade-off theory suggests that # 0 and the variation in
MDR*i,t+1 should be non zero.
Firms would shift their leverage ratios forward the target ratio immediately in perfect and
frictionless market (there are no costs of transaction and adjustment). However, in an
imperfect world, immediate movement of debt ratio toward the desired ratio might be
prevented. Firms intend to adjust their leverages toward the optimal leverage level but
partially. Following the ideas of Rangan and Flannery, we construct a standard partial
adjustment model as follows:
(

(3)

In which, is the speed adjustment toward optimal leverage level of firm i at time t.
Substitute equation (2) into equation (3) we have the standard model which is used to test
the speed adjustment toward optimal level mentioned by the tradeoff theory.
(4)

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Equation (4) will be used as the core specification for the paper. Because pecking order
theory mainly refers to internal factors inside firms; hence, while using market debt ratio in
testing trade-off theory, we are going to use book debt ratio (total of short term and long
term interest-bearing debt to total assets) in testing pecking order theory regression instead.
Pecking order theory implies that firms financing deficit is one of the most important
explanatory variables to the choice of capital funding. Due to adverse selection, firms intend
to balance the need of dividend payment, new investment and working capital by internal
resources before borrowing debt.
Table 2, page 229, Frank and Goyal (2003) mentioned a firms financing deficit (FINDEF),
which was defined as the ratio of sum of (dividend payments + investment +change in
working capital internal CASHFLOW)/total assets. We will use this definition of FINDEF in
our regression model. Therefore, replacing the book debt ratio for market debt ratio and
adding FINDEF (financing deficit) as an explanatory variable into equation (4), we have the
pecking order behavior testing specification as follows:
(5)
The equation (5) implies that a firms financing deficit clearly explains current changes in its
book debt ratio. Because BDRi,t+1 = BDRi,t+1 - BDRi,t, substitute into (5) we will have:
BDRi,t+1= Xi,t+ (1- ) BDRi,t + FINDEFi,t+1 + i,t+1

(6)

Running regression by equation (6), if financial deficits variable (FINDEF) is found

statistically significant to book debt ratio, pecking order theory is suggested as applicable in
Vietnamese market. However, if FINDEF is significant but it makes no differences/changes
on the coefficient of the other explanatory variables used in equation (4), we can conclude
that pecking order theory is just a subset of trade-off theory, or on the other hand, trade-off
theory is a generalized model of pecking order theory.

4. Data and Variable Explantations

Generally in Vietnam, only listed companies are forced to publish their audited financial
reports, business performances and activities while unlisted firms are free to this obligation.
In addition, contrary to the information transparency of listed companies, data collected from
unlisted companies might be manipulated for private purposes of companies owners.
Therefore, to entrust the empirical results, the paper only focused on the database from
companies listed in Vietnam stock exchange.
In addition, we tried to ensure the database used in the paper is sufficient in term of time
period and number of observations. Hence, we considered all the listed firms in Vietnam
stock market that we could access their data within the period of at least four years.
Consequently, from those reasons, data in this paper were collected from over 300 hundred
listed companies categorized by 15 industries (classified by Vietnam Standard Industrial
Classification 2007); in Hanoi and Ho Chi Minh stock exchange, from 2005 to 2011. We
eliminated all the firms which have been listed in the stock exchange after 2007. In addition,
to guarantee our database is consistent in term of demand side only, we ignored all the
financial companies and banks listed in the stock exchange because they are normally
considered as debt suppliers.

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We re-defined industry variable down into 5 sectors to make the empirical analysis become
more precise. Industry variable included: Agriculture, forestry and fishing; Energy
exploitation and distribution; Manufacturing; Construction and Transportation; and Other
industries. However, some variables contained missing observations and we decided not to
drop any of those variables. Thus, an unbalanced panel dataset was observed and used for
the regression test with total of over 1600 firm-year observations.
Because, the paper aims to test three hypotheses mentioned in Section I, we divided our
data into two subsets, state-owned firms and private firms. Based on the state proportion in
firms ownership structure, we defined a state-owned firm as a firm with at least 36 percent
of equity belonging to the government, and vice versa, a firm with less than 36% of
government control was considered as non state-owned (or private) firm. We chose 36% of
equity ownership because this percentage was legally regulated as the minimum
requirement for shareholders to have the right of veto, i.e., the right or the power to reject
any business proposal given by other shareholders. Moreover, 36% of registered capital
owned by state normally guarantees that government will have two members in the Board of
Directors, which allows government increases its direct control over the firms regular
activities and strategies. We did not use the normal rate 50% of state ownership to split our
sample because this percentage leads to a huge unequal subset of our data.
The determinants of capital structure were mainly selected as previous papers have done.
Those factors appeared frequently in the literature review of Fama and French (2001),
Hovakimian (2003) and Flannery and Ranga (2006). Two other factors added by us were
FIRM-AGE and FIRM-CASH at the fiscal year end. Proxies and expectations of those
factors are as followsi:
MDR: This variable stands for market debt ratio. It is defined as total debt (short-term debts
plus long-term debts) to the sum of total debt and a multiple of outstanding shares and stock
price.
BDR: this variable stands for book debt ratio of the firm. It is defined as the ratio of total
debts (short-term plus long-term interest bearing debts) to total assets. Generally, BDR is
smaller than MDR in our study.
LN_TA: this is the logarithm of total assets. It shows firm size or business scale of firms.
Blackwell and Kidwell, 1988, with the flotation-costs assumption, considered that larger
firms preferred to use more debts than smaller ones in order to make economies of scale. In
addition, larger firms may have lower asset volatility and they might have more power to
access debt supply market.
EBIT_TA: Earning before interest and tax to total assets. This factor indicates the ability of
firms on paying loans. EBIT_TA also shows how the profitability affects debt borrowing
behaviors. It is expected to be positively correlated to the leverage level. However, on the
other hand, because of high retained earnings, firms might borrow less debt to reduce the
bankruptcy risks and protect their profitabilitys proxy. Therefore, a firm with high EBIT could
prefer to operate with both higher and lower portion of interest-bearing debt.
MB: Market to book ratio of assets. Following the asymmetric information assumption, firms
with high market to book ratio (MB) are considered as having brightly prospective growth.
Therefore, those firms will try to keep their debt ratio low and try to protect these

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advantages by limiting the leverage level. The market timing theory also predicts lower level
of debt for firms with high market value of stock price.
DEP_TA: This is the ratio of depreciation to total asset of the firm. High depreciation leads
to low accounting profit but high CASH capacity. Therefore, firms with high depreciation
may have more cash and need less debt from borrowing activities compared to firms with
low depreciation.
FIRM_AGE: Traditional and long historical firms might be well-known with financial
intermediary system. They can borrow with ease, and consequently, firms with long history
might be able to remain high leverage ratio to receive the benefits of tax deduction.
However, on the other hand, long traditional firms may also have advantages of using the
non-interest bearing debt from late payment policies from their suppliers, which lead to a
low level of debt.
FA_TA: This stands for the ratio of fixed asset to total assets. Firms with high proportion of
fixed assets might refer to have high production capacity. As a result, those firms might
need more debts to support for their activities. That means a positive relationship between
FA_TA and leverage ratio is expected.
CASH: Is the beginning CASH in the balance sheet of financial report. This variable is only
used when the paper tests the existence of pecking order theory. Because we believe
CASH policies have a strong effect on the FINDEF, the main explanatory variable in the
empirical test of pecking order theory, and the behavior of debts.
INDU: Is defined for Industry classification and we encoded 5 industries as from 1 to 5.
FINDEF: Denoted as financing deficit. This ratio is defined as the ratio of a sum of (dividend
payments + investment + change in working capital internal cash-flow) to total assets.
This ratio is assumed to wipe out all other variables significant effect. If this ratio is
significant and creates remarkable changes in other variables in equation (5), it is
considered as an obvious signal for the existence of the pecking order theory in Vietnamese
market.
The following table briefly specifies statistic summary of our database used in the paper:

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Table 1: Summary Statistics of the data
Variable
YEAR
INDU
MDR
BDR
FINDEF
CASH
LNTA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB

Obs

Mean

Std. Dev.

Min

Max

1654

2008.710

1.671

2005

2011

1654

3.438

1.440

1.000

5.000

1654

0.299

0.283

0.000

0.900

1653

0.224

0.208

0.000

0.901

1574

-0.039

0.224

-1.181

1.834

1568

10.196

0.774

7.330

12.570

1654

26.536

1.436

23.220

31.201

1654

0.066

0.102

-0.901

0.609

1608

0.037

0.054

-0.650

0.750

1654

0.306

0.210

0.001

0.976

1654

20.826

12.752

5.000

67.000

1654

33.426

39.391

0.900

560.000

Noted: Variables are described in the description above.

In average, the market debt ratio differs from book debt ratio an amount of 0.07 and they
both range from 0 to over 0.9 percent. This shows our data cover a wide range from nonleverage to heavy leverage-bearing firms. In fact, MDRs in some cases equaled to zero,
because, some firms have recently joined the market and they had no demand (or hard to
access) for long-term debt for some first years, whereas at some moments, MDRs of some
companies in construction industry were close to the value of 1 because at that time, the
price of outstanding shares decreased dramatically and the number of outstanding shares
was small too. Particularly, the maximum MDR is approximated to 1. Book debt ratio also
follows the trend of MDR. Values of BDR fluctuate from 0 to 0.9. The book debt ratio which
approximates 90% reflects the fact that firm heavily depended on outside resources and it
was in danger of bankruptcy. Beside that, average debt levels for MDR and BDR are around
0.29 and 0.22, respectively. This guarantees the sufficiency of our sample, a great range of
leverage ratio from different industries but with reasonable mean.
Data of other variables also present gaps among firms. We considered from very young firm
which was lately established within 5 years to very traditional and long-lasted history firm
which was operated over 60 years ago. With the wide set of data, we expected that our
empirical results could be applied to explain for financial behavior of all firm types. However,
some observations were abnormally far away from most of other observations as running
firm-level empirical analysis, outlier error was another issue that we considered. A paper
written by Ghosh and Vogt, in Joint Statistical Meeting of American Statistical Association,
2012, questioned on how small of the tail probability is to declare a value of an outlier. They
figured that while the outliers might not be in the range of the model or a pattern, most of the
observations seem to follow the same principles or satisfy the model. In general, treatments
for outlier issues are often conducted by one of these three methods: 1) keeping outliers as
normal data. In this case, we will ignore the issue of outlier and conduct the empirical test
with the whole sample of our database; 2) wisorizing the outliers at a given level (e.g. at the
level of 1% or 5%); and 3) eliminating/trimming outliers from database or the sample.
While wisorizing or eliminating outliers will create statically bias and undervalue the outliers
because of the significance impact by decreasing standard errors, keeping them as normal
data in regression process might lead to overvalue the outliers and may create remarkable
results which vary remarkably from the true population value. However, our database was

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collected from HOSE and HNX which were quite standardized in the requirements of the
firms equity size, profitability and transparence. In addition, our database was slightly small
for a panel regression; therefore, we decided to treat potential outliers as normal data in our
empirical test to ensure the variability of the sampleii.
In addition, our explanatory variables looks closely related because we have employed
several internal characteristics of the firm in empirical analysis. Therefore, we conducted a
multi-collinearity test followed by instruction of Philip B. Ender, from UCLA Office of
Academic Computing, distributed on 23/11/2010, to isolate the effect of each control
variable to dependent variable.
Table 2: Multi-collinearity Test
Variables
CASH
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB
Mean VIF

1.14

VIF

SQRT-VIF

Tolerance

R-Squared

1.10

1.05

0.9091

0.0909

1.17

1.08

0.8531

0.1469

1.23

1.11

0.8146

0.1854

1.11

1.05

0.9005

0.0995

1.13

1.06

0.8832

0.1168

1.02

1.01

0.9789

0.0211

1.20

1.09

0.836

0.164

Condition Number

1.6808

From table 2, VIFs, variance inflation factor, and Condition Number, index of the global
instability of regression coefficients, were all less than 2. That means each independent
variable could be considered as non-linear combination with other independent variables in
our model. Consequently, multi-collinearity is not a serious problem for our empirical
analysis.
Finally, to ensure the resulting standard errors are consistent with the panel autocorrelation
and heteroskedasticity issues, we used robust standard errors in our regression analysis.

5. Trade-off Theory and Regression Test Results

The first step of this study was testing the existence of an optimal level of debt for each firm
given its characteristics. The explained variable is MDR, and explanatory variables included
firm size, profitability, market-to-book value of total assets, firm age, depreciation and fixed
assets. Running unbalanced panel regression by OLS, random effects and fixed effects,
with the results can explain over 44% of the sample test (R2=0.4). We found that the desired
market debt ratio does exist but significantly depends on plausible firm features. In this
case, those features are firm size, profitability, fixed assets and prospective firm growth.
However, depreciation and history of the firm do not statistically influence the debt choice.
Industry groups and time-varying effects do not elicit changes, as we received the same
results for the significance of control variables to the output when adding the dummy
variables in columns (4), (5) and (6), except for the variable of market-to-book ratio of
assets.

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Table 3: Testing optimal leverage and firms featuresiii
Equation 2: MDR*i,t+1= Xi,t
In which, Xi,t included:

LN_TA: logarithm of total asset denoted for firm size

EBIT_TA: Earning before interest and tax/total asset denoted for profitability
DEP_TA: Depreciation/total asset denoted for Depreciation
FA_TA: Fixed asset/total asset denoted for Fixed asset
Firm_Age: total year since firm established denoted for history of firm
MB: Market to book ratio of assets denoted for prospective growth in future
(1)
Control
Variables

LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB

OLS

.0583***
(15.44)
-1.179***
(-20.11)
-0.042
(-0.42)
0.104***
(3.97)
0.001*
(2.41)
-0.002***
(-11.96)
1608
0.4473

(2)
Random
effects

.0882***
(15.61)
-.8922***
(-14.98)
-.1389
(-1.55)
.1301***
(3.77)
.0007
(1.05)
-.0016***
(-13.17)
1608

(3)
Fixed
effects

.0881***
(15.61)
-.8922***
(-14.98)
-.1388
(-1.55)
.1300***
(3.77)
.0007
(1.05)
-.0016***
(-13.17)
1608
.4054

(4)

(5)

(6)

OLS
(dummy)

Random
effects
(dummy)

Fixed
effects
(dummy)

.0407***
(11.20)
-1.116***
(-20.56)
.09005
(0.93)
.1662***
(6.67)
.0008*
(2.29)
-.0004**
(-2.73)
1608
0.5540

N
R2 (within)
t statistics in parentheses - legend: * p<0.05; ** p<0.01; *** p<0.001

.0544***
(9.85)
-.8392***
(-15.12)
-.0377
(-0.44)
.1906***
(6.00)
.0006
(1.03)
-.0001
(-1.27)
1608

.1374***
(9.88)
-.6361***
(-10.37)
-.0526
(-0.60)
.1784***
(4.08)
-.0024
(-0.65)
.0001
(0.60)
1608
0.4969

The empirical result regarding the relation between firm size and debt ratio is consistent with
the corporate finance theory when it suggests bigger firms borrow more debt than smaller
ones. An increase in total assets would also lead to 6% debt ratio increase. In addition, our
result is also consistent with other research findings when profitability (EBIT_TA) is
negatively related to the debt ratio and production capacity (FA_TA) is positively related.
This confirms that if one company is performing well and making profits, it might have more
internal funds to support operational activities such as investments and paying out dividends
to reduce the distress risks rather than borrowing funds. On the contrary, firms with higher
production capacities (fixed assets) use more debts because they may need more capital to
support new production development opportunities. The result of the MB variable in our test
showed that even the growth opportunity is significantly negative to the market debt ratio; it
might have no effect on the debt ratio when its tested coefficient only reaches around
0.2%.Unlike what normal theory has predicted, a negative relationship between non-debt
tax shields and debt tax shields, our result failed to find a significant effect of depreciation,
DEP_TA, on the firms leverage level. A similar result is also applied for the correlation
between FIRM_AGE and debt ratio. The firms history variable does not lead to a difference
in borrowing debts. A firm with a long history might have a smaller market to debt ratio than
newly established firms because they might have better trade-credit policies and vice-versa,
start-up firms might borrow more in order to purchase initial fixed assets.

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Dereeper & Trinh

We continued our analysis by determining the effects of government control on fund-raising
behaviours by running an empirical test with 689 observations of state-owned firms. As
denoted in equation (4), the lead MDRi,t+1 (MDR of firm i at time t+1) is explained by a set of
a firms characteristics, Xi,t, and its current MDRi,t (MDR of firm i at time t). We continuously
run the OLS, random effects and fixed effects analysis for the both cases, with and without
dummy variables.
Based on the results of Table 4, we figured that OLS and random effects bring similar
results regardless of if time and industry group dummies are included in the regression
analysis. Firms with very high leverage will decrease their leverage to match the target level
of debt and vice versa, since the adjustment speed is naturally bounded between zero and
unit. Firms with more assets in a given year borrow more in the following year, even if they
are controlled by the government. State-owned firms also fit in our assumption that high
profitability will help to reduce the dependence of debt usage. MB remains negatively
related to the debt ratio. However, when running fixed-effects analysis, we found no
significance between the leverage level at time t and the leverage level at time t+1. The
significance of the partial adjustment model moved slightly when dummy variables were
included in the regression test. Leverage levels were proven to adjust dramatically toward
the long-term debt target, even at the significance level of 5%.
Nevertheless, the dynamic model contained the lagged dependent variables that yield
inconsistent estimates because regressors and error terms (disturbances) are correlated;
the strict exogeneity condition was not satisfied. Therefore, least-square and fixed effects
models might not be the proper techniques for running the regression analysis. To solve
these problems, we applied the ArellanoBond difference GMM estimator in Stata, written
by Roodman (2006), and presented the results in column (7). The coefficient of lead
MDRi,t+1 on MDRi,t implies that state-owned firms rapidly amend their debt ratios to optimum
levels. In the ordinary least squares and random-effects models, state-owned firms adjust
approximate 37% within one year to reach the target debt ratio. This adjustment speed
predicts that one typical state-owned firm only needs approximately 32 months to close the
gap between the current and the optimal leverage levels. In the GMM method, a more rapid
adjustment speed was found at the rate of 66%. This means that if everything is constant,
after 18 months, state-owned firms might reach the target leverage level. Therefore, we can
conclude the cost of deviating from the optimal debt ratio outweighs other considerations
such as internal funds and issuing equity, which are mentioned in the pecking order theory.

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Dereeper & Trinh

Table 4: Testing the partial adjustment model state-owned firmsiv
MDRi,t+1= Xi,t+ (1-) MDRi,t + i,t+1
Control
Variables
MDR
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB
N
R2 (within)

(1)

(2)

(3)

(4)

OLS

Random
effects

Fixed
effects

OLS
(dummy)

.6344***
(15.89)
.0406***
(6.59)
-.3514***
-3.61)
-.0729
(-0.54)
.0694
(1.81)
.0007
(.08)
.0001***
(0.59)
531
.5878

.6268***
(15.62)
.0413***
(6.63)
-.3503***
(-3.58)
-.0760
(-0.56)
.0711
(1.84)
.0007
(1.10)
.0001***
(0.60)
531
0.1691

.0558
(1.12)
.2222***
(10.35)
.0882
(0.69)
-.1325
(-0.95)
.1253
(1.42)
.0781
(1.00)
.0003
(1.33)
531
0.2841

.6507***
(16.61)
.0365***
(6.31)
-.1982*
(-2.06)
.0580
(0.46)
.0493
(1.37)
.0004
(0.78)
-.0007**
(-2.63)
531
.6745

(5)
Random
effects
(dummy)
.6087***
(15.16)
.0391***
(6.31)
-.1961*
(-2.00)
.0535
(0.42)
.0596
(1.56)
.0005
(0.78)
-.0006*
(-2.53)
531

(6)
Fixed
effects
(dummy)
.1122*
(2.21)
.1141***
(4.12)
.1559
(1.28)
-.0379
(-0.28 )
.1021
(1.23)
.1564*
(2.10)
-.0001
(-0.53)
531
0.3842

(7)
GMM

0.438***
(4.530)
0.0981***
(4.230)
-0.333
(-1.48)
-0.116
(-0.29)
0.448**
(3.310)
0.001
(0.380)
0.00105**
(2.800)
531

t statistics in parentheses - legend: * p<0.05; ** p<0.01; *** p<0.001

Table 5 shows the trade-off theory testing results for private firms. Using the same
techniques inform the state-owned firm sample, the significant level seems to reflect the
same results as shown in Table 5. However, some features seem to lose their significance
on debt choice. Firm size and profitability maintain positive relationships with the debt level,
while the remaining parameters were insignificant in OLS, random and fixed effects
regression analysis. The support for trade-off theory of optimal debt level does not seem as
strong in fixed effects with dummies inclusive and GMM analysis, when we found only one
significant control variable determined for the long-run target debt ratio in each analysis.
Despite this, the results still show a strong significance at 0.1% between the current debt
ratio and the desired debt ratio. In the GMM analysis, we found the adjustment speed had a
value consistent with the results in OLS and random effects analysis. The coefficient
estimator of MDR at time t, which equals to 0.78 in the GMM model, predicts that the speed
of adjustment toward the optimal debt level of private firms is much lower than that of stateowned firms. While the speed of adjustment is 66% for state-owned firms, private firms only
adjusted at the rate of 32%. This result implied that private firms complete the required
adjustment speed within 37 months in order to close a leverage gap between the current
and optimal market debt ratios.

126

Dereeper & Trinh

Table 5: Testing partial adjustment model private firms
( MDRi,t+1= Xi,t + (1-) MDRi,t + i,t+1 )
(1)
OLS

Random
Effects

Fixed
Effects

OLS with
dummy

0.745***

0.734***

0.0685

0.709***

(5)
Random
Effects with
dummy
0.683***

(22.58)

(22.03)

(1.54)

(21.74)

(20.57)

(2.29)

(9.36)

0.0224***

0.0232***

0.199***

0.0193***

0.0200***

0.0324

0.03

(4.38)

(4.45)

(11.15)

(4.12)

(4.10)

(1.43)

(1.81)

-0.325***

-0.325***

-0.159

-0.243**

-0.241**

-0.0758

-0.38

(-4.04)

(-4.01)

(-1.67)

(-3.28)

(-3.21)

(-0.88)

(-1.88)

-0.249*

-0.252*

-0.0757

-0.172

-0.177

-0.104

1.53

(-1.98)

(-2.00)

(-0.58)

(-1.47)

(-1.50)

(-0.84)

(1.72)

-0.0179

-0.0184

-0.025

0.0542

0.0578

0.149*

-0.16

(-0.52)

(-0.52)

(-0.35)

(1.66)

(1.72)

(2.27)

0.000182

0.000188

-0.00098

0.000294

0.00032

-0.00317

(-1.28)
0.00

(0.35)

(0.35)

(-0.22)

(0.60)

(0.63)

(-0.85)

(1.67)

0.000161

0.000163

0.000295

-0.000196

-0.000182

0.000264

0.00111**

(0.98)

(0.98)

(1.70)

(-1.16)

(-1.06)

(1.47)

(3.01)

771

771

771

771

771

771

771

R2

0.5938

0.0967

0.2550

0.6894

0.3004

0.4328

Control
Variables
MDR
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB

(2)

(3)

(4)

(6)

(7)

Fixed Effects
with dummy

GMM

0.0972*

0.780***

t statistics in parentheses - Legend: * p<0.05, ** p<0.01, *** p<0.001

To clearly understand how private firms and state-owned firms depend on debt, we
conducted a mean regression test on the leverage levels of these two groups. The result
shows that both groups seemed to equally use debt to support for their financial demands. If
private firms, on average, preferred their market debt ratios to be around 0.3, state-owned
firms preferred virtually the same ratio, which was determined to be around 0.29. The gap
between private firms and state-owned firms market to debt ratios is only about 0.03.
Unfortunately, the t test is only valued at 0.26, which is less than 1.96, and the two-tailed p
equalled 0.796. Therefore, we were unable to provide any conclusions to suggest which
type of firm used more debt.
Table 6: Testing the difference between two means.
MDR
Private_firm
State_firm
Gap

Coef.
.3007
.2971
.0036

Std.Err
.0091
.0107
.0140

P> |t|

33.05
27.59
0.26

0.000
0.000
0.796

[95%
Conf.
.2829
.2760
-.0240

Interval
.3186
.3182
.0312

In conclusion, unlike Nguyen (2006), and Okuda and Nhung (2012), the first hypothesis of
the paper is rejected when we found no evidence to suggest state-owned firms use more
debt than private firms. However, we found an application of the trade-off theory in the
Vietnamese market, even though not all of the control variables determining a firms longrun target debt ratio were statistically significant. The second hypothesis is confirmed when
Information regarding both private and state-owned firms suggests that an optimal level
exists where the firms would maximize value by utilizing current resources.

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Dereeper & Trinh

6. Pecking Order Theory and the Empirical Implication
The pecking order theory implies that firms have no strong preferences on how much debt
should be used to support for their financial deficits. Therefore, firms might not consider
adjusting their leverage level to reach the optimal level of debt as top priority when they
need to raise funds. We applied Frannery and Rangans (2006) concept to build the
estimated model by adding the financing deficit into the model as another control variable
with the same variables used in the trade-off theory of capital structure, found in section
five. The testing model was described in section four.
Frank and Goyal (2003) stated that the pecking order theory implies that the financing
deficit ought to wipe out the effects of other variables. If the financing deficit is simply one
factor among many that firms trade off, then what is left is a generalized version of the
trade-off theory (p.219). Although, this conclusion might not perfectly explain the events in
emerging markets such as Vietnam, we still used the ideas of those authors to conduct our
model specification and run the empirical test for the application of the pecking order theory
in Vietnam.
Running the pecking order theory test for state-owned firms with different techniques used
in section five, we figured that coefficients between BDRi,t and BDRi,t+1 are all statistically
significant. In addition, we found that regardless of the amount of beginning surplus cash,
firms would still borrow at a given level of debt. This is also moderately consistent when
depreciation is unrelated with the outcome. The application of the pecking order theory
seems evident when our results indicated that adding financing deficit substantially
indicated the significance of other explanatory variables. Production capacity and growth
opportunities were no longer statistically significant to the book debt ratio. This seems
unlikely to Flannery and Rangan, since pecking order forces do not appear to be part of
what was referred to as the generalized version of the trade-off theory (Frank and Goyal,
2003, p. 219). However, we only found the coefficient of financing deficit to be statistically
significant at 5% when running the OLS and random effects without dummies. With N small
(N=493), OLS and random effects analysis created the exact same outcomes in our paper.
However, if we considered industry and the time-varying impact on book debt ratio in the
OLS and random-effects analyses, we found that the FINDEF coefficient was insignificant,
consistent with the results received when running a fixed effects and GMM regression
analysis. Because of the limitations of OLS and random effects regression analyses, which
was mentioned in previous section, results from these two analyses are considered biased
and inconsistent. Therefore, we can conclude as implied by GMM model that the pecking
order implication has failed to explain debt-increasing behaviors of state-owned firms in
Vietnam.

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Dereeper & Trinh

Table 7: Pecking order testing state-owned firms
BDRi,t+1= Xi,t + (1-) BDRi,t + FINDEFi,t+1 + i,t+1
Control
Variables
BDR
CASH
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB

FINDEF
N

(1)

(2)

(3)

(4)

(5)

OLS

Random
Effects

Fixed
Effects

OLS with
dummy

Random
Effects with
dummy

(6)

(7)

0.625***

0.625***

0.140**

0.625***

0.625***

Fixed
Effects
with
dummy
0.148**

(17.83)

(17.83)

(2.82)

(17.22)

(17.22)

(2.94)

(6.60)

-0.00191

-0.00191

0.00965

-0.00288

-0.00288

0.0110

-0.0135

(-0.26)

(-0.26)

(0.68)

(-0.38)

(-0.38)

(0.77)

(-0.47)

0.0248***

0.0248***

0.0609***

0.0268***

0.0268***

0.0497*

0.0421***

(5.19)

(5.19)

(3.44)

(5.33)

(5.33)

(1.99)

(3.44)

-0.154*

-0.154*

0.154

-0.0771

-0.0771

0.186

-0.112

(-2.08)

(-2.08)

(1.49)

(-0.96)

(-0.96)

(1.75)

(-0.80)

0.0813

0.0813

-0.0909

0.128

0.128

-0.0587

0.115

(0.69)

(0.69)

(-0.68)

(1.08)

(1.08)

(-0.44)

(0.49)

0.0421

0.0421

0.0297

0.0474

0.0474

0.0264

0.157

(1.43)

(1.43)

(0.41)

(1.57)

(1.57)

(0.36)

(1.89)

0.000272

0.000272

0.0341

0.000253

0.000253

0.0166

0.00127

(0.59)

(0.59)

(0.55)

(0.54)

(0.54)

(0.26)

(0.83)

-0.000255

-0.000255

-0.000263

-0.000555**

-0.000555**

-0.000274

0.0000264

(-1.46)

(-1.46)

(-1.38)

(-2.59)

(-2.59)

(-1.11)

(0.08)

-0.0544*

-0.0544*

-0.0360

-0.0404

-0.0404

-0.0285

-0.0383

(-1.98)

(-1.98)

(-1.18)

(-1.44)

(-1.44)

(-0.92)

(-0.62)

493

493

493

493

493

493

493

GMM
0.545***

t statistics in parentheses - Legend: * p<0.05, ** p<0.01, *** p<0.001

Running the same regression with the database of private firms, we also found the results of
the financing deficit on a firms choice of debt that were consistent with state-owned firms.
Although FINDEF substantially alters market book and depreciation signs and the significant
coefficient level, there was no indication to reject the null hypothesis of the regression
testing. Therefore, the pecking order of using internal funds first and issuing equity as a last
resort should not be considered as the theoretical explanation for lending behaviors of
private firms.

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Dereeper & Trinh

Table 8: Pecking order testing private firms
BDRi,t+1= Xi,t + (1-) BDRi,t + FINDEFi,t+1 + i,t+1
(1)

(2)

(3)

(4)

(5)

(6)
Fixed
Effects
with
dummy
0.0782*

(7)

Control
Variables

OLS

Random
Effects

Fixed
Effects

OLS with
dummy

BDR

0.656***

0.608***

0.0963*

0.650***

Random
Effects
with
dummy
0.593***

(22.86)

(20.43)

(2.45)

(21.47)

(18.85)

(1.99)

(6.29)

-0.00267

-0.00342

-0.00512

-0.000707

-0.00139

-0.00482

-0.00334

(-0.39)

(-0.48)

(-0.55)

(-0.10)

(-0.19)

(-0.54)

(-0.14)

0.0177***

0.0193***

0.0462**

0.0186***

0.0200***

-0.0134

0.0332**

(4.53)

(4.60)

(3.30)

(4.64)

(4.59)

(-0.70)

(2.65)

-0.119*

-0.120*

0.00794

-0.103

-0.103

0.0103

-0.342*

(-2.03)

(-1.99)

(0.11)

(-1.74)

(-1.69)

(0.14)

(-2.54)

-0.268*

-0.275*

-0.208

-0.314**

-0.321**

-0.217

0.0880

(-2.51)

(-2.54)

(-1.75)

(-2.85)

(-2.87)

(-1.81)

(0.16)

0.0898***

0.0941***

0.0850

0.110***

0.117***

0.146**

0.216*

(3.42)

(3.38)

(1.54)

(3.98)

(4.00)

(2.67)

(2.47)

0.000220

0.000238

-0.00126

0.000237

0.000265

-0.00126

-0.000271

(0.57)

(0.56)

(-0.42)

(0.60)

(0.60)

(-0.43)

(-0.19)

-0.000155

-0.000165

-0.000255*

-0.000299*

-0.000289*

-0.0000751

-0.000362

(-1.35)

(-1.42)

(-1.99)

(-2.19)

(-2.08)

(-0.50)

(-1.31)

-0.0101

-0.0116

-0.0155

0.00609

0.00468

-0.0180

-0.0168

(-0.48)

(-0.55)

(-0.70)

(0.29)

(0.22)

(-0.81)

(-0.27)

708

708

708

708

708

708

708

CASH
LN_TA
EBIT_TA
DEP_TA
FA_TA
FIRM_AGE
MB

FINDEF
N

GMM
0.434***

t statistics in parentheses - Legend: * p<0.05, ** p<0.01, *** p<0.001

The pecking order specification continued to be tested by using the market debt ratio (MDR)
instead of the book debt ratio (BDR). The results remain unchanged, compared to the
previous regression. Since the techniques were identical, we do not reiterate the results.
After completing all empirical tests, we concluded that the pecking order theory failed to
explain the capital behaviours of both private and state-owned companies in Vietnam from
2005 to 2011.

7. Conclusion
In conclusion, we found that an optimal level exists where firms are able to maximize their
earnings in the Vietnamese market. Our findings indicated that the pecking order theory is
not applicable for both state and private firms when the internal deficit does not rule out the
debt choice behavior of firms. Internal cash flow has no significant effects on the debt ratio.
Given the plausible features, both private and state-owned firms rapidly adjusted toward the
time-varying desired leverage level. While state-owned firms only needed 18 months to
close the gap between the current leverage level and target leverage level, private firms
needed double the time-period to fulfil the gap. This might imply that government
shareholders require a more constrained and precise debt policy, compared to other
shareholders in private companies. However, in the capital structure aspect, state-owned

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Dereeper & Trinh

firms and private firms seem to hold an equal ratio in long-term debt, and no evidence was
found to prove which type of firm is using more debt.
This study only used a database of listed companies within the maximum time period of
seven years. Several state-owned and private companies still have not decided to
participate in the exchange market. Therefore, it might be a limit of our panel regression
analysis when the data consists of T small and lagged variables. In addition, we only
considered the pecking order theory and the static trade-off theory in this study. Other
capital structure theories, such as market timing theories, were not included. Moreover, we
also only considered internal factors of the firms. Other external parameters that could have
been included are corporate tax policy, bank credit supply and macro-economic factors.
Therefore, these issues can be addressed in future capital structure studies for the Vietnam
case.

Endnotes
i

We did not add R&D expenditures as a determinant of capital structure in our empirical analysis, because
most of listed companies in Vietnam do not seriously spend their money on research and development
activities. Therefore, R&D expenditures generally equal to zero or omit in the database.
ii In fact, we also conducted regression analysis by using wisorizing technique at a given 1% level as a
robustness check for outliers. However, we found that the results remained unchanged, compared to the
results we have described in main part of the paper. Therefore, to make the paper short and simple, we
decided not to provide wisorizing empirical results in our paper.
iii
Dummy variables here are considered as industry group (INDU) and year (YEAR) dummies. However, due
to the aim of our test is proving coefficients of Xi are non zero, hence, we do not present the regression
results of dummies variables in table 4 and other tables afterward.
iv
From Table 5 afterward, we will not report the description of Independent Variables X i,t as they are all
described in table 4 and section three.

References
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Financial Markets: Integration, Innovation and Challenges (International Finance
Review, Volume 8), Emerald Group Publishing Limited, pp.307 326.
Blackwell, DW. & Kidwell, DS 1988, An investigation of cost differences between public
sales and private placements of debt, Journal Financial Economics, vol. 22, issue 2,
pp. 253-278.
Bruslerie, H & Latrous, I 2012, Ownership structure and Debt leverage: Empirical Test of a
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