UNIVERSITY OF ECONOMICS ERASMUS UNVERSITY ROTTERDAM HO CHI MINH CITY INSTITUTE OF SOCIAL STUDIES VIETNAM THE NETHERLANDS VIETNAM – THE NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS INTER-RELATIONSHIP BETWEEN CAPITALSTRUCTURE, FREE CASH FLOW, DIVERSIFICATION AND FIRM PERFORMANCE MASTER OF ARTS IN DEVELOPMENT ECONOMICS BY Mr. THAI BA TOAN Academic Supervisor: Dr. PHAM DINH LONG Ho Chi Minh City, December 2016 LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS INTER-RELATIONSHIP BETWEEN CAPITALSTRUCTURE, FREE CASH FLOW, DIVERSIFICATION AND FIRM PERFORMANCE A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By Mr. THAI BA TOAN Academic Supervisor: Dr.
PHAM DINH LONG Ho Chi Minh City, December 2016 LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com ASTRACT Improving firm performance is always a top concern of companies. The global financial crisis and public – debt crisis in Europe has had a negative impact on the economy of Vietnam, especially on Vietnamese companies. Therefore, the issues of performance enhancement, escaping from stagnating production and increasing sales are more necessary with the company. Besides, the trend of diversification has become more common in Vietnamese companies.
These companies are attracted to investment projects outside the industry, even these industries are not related to the core business of the companies. The selection of the investment plan of how, what industries, how combining funds, or the evaluation of the firm operations to take the right investment are always the most important issues. The objective of the study was to find evidence of the inter – relationship between the four factors capital structure, free cash flow, diversification and firm performance in the Vietnamese market. The study used data from 118 non-financial companies listed on the Hanoi Stock Exchange (HNX) and Hochiminh Stock Exchange (HOSE) in the period of 2009-2014.
By using 2SLS and 3SLS regression methods, combined with comparable results from Odinary least squares estimator, the study found out the evidence of the negative impact of firm performance to leverage, but this impact is positive to diversification. Free cash flow was also shown to have a positive impact on the firm performance and diversification. And finally, leverage reduces free cash flow in a company. From the empirical results, the study also proposes some advices to support companies in making decisions about capital structure and investment.
The study also points out some of its limitations and futher research. Keywords: Capital structure, free cash flow, diversification, firm performance, holistic analysis i LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com ACKNOWLEDGEMENT This thesis is the last exercise, which summarized the process of learning and training in the postgraduate programe for two years. The completed study would not be accomplished without any supports. Therefore, I gratefully give acknowledgement to all the assistances and motivations during the time of doing this research as a requirement of completing my Master Degree of Arts in Development Economics.
Foremost, I would like to sincerely and gratefully thank Dr. Pham Dinh Long, my supervisor, for his great assistance, principal and valued advice during my thesis finish. He always stood by me, showed me the passion and the best way to finish my thesis. Without his counseling, I were not able to accomplish this study.
I would like to thank the Vietnam – Netherlands Programme, especially professors and staffs for their help during my thesis process. The professors not only gave me the knowledge but also created the best conditions for me in order to collect data and write this thesis. The staffs of Vietnam – Netherlands Programme who were very friendly and kind, always willing to help me on the physical facilities as well as references. I would like to thank all my friends, who never stopped encouraged and helped me when I met any difficulties in doing the thesis.
Last but not least, I would like to give my deep gratitude to my family for their sacrifices to help me not only in studying in Master Degree, but also in my whole life. ii LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com CONTENTS CHAPTER 1: INTRODUCTION. Motivation of the research. Structure of the research.
4 CHAPTER 2: LITERATURE REVIEW. The study of the relationship between firm performance, capital structure, free cash flow and diversification. Capital structure and firm performance. Free cash flow hypothesis.
Diversification discount and free cash flow. The relationship between diversification and capital structure. Summarize the previous studies about the relationship between the capital structure, free cash flow, diversification and firm performance. Free cash flow.
Related entropy and unrelated entropy. Total debt leverage. 44 iii LUAN VAN CHAT LUONG download : add luanvanchat@agmail. Two-Stage Least Squares (2SLS) estimator.
Three – Stage Least Squares (3SLS). Effect of free cash flow, diversification and leverage on firm performance. Effect of leverage to free cash flow of the company. Effect of free cash flow, company performance and leverage to the diversification of the company.
Effect of diversification and company performance to leverage. Effect of free cash flow, diversification and leverage to company performance. Effect of leverage to free cash flow of the company. Effect of free cash flow, company performance and leverage to the diversification of the company.
Effect of diversification and company performance to leverage. Inter – relationship among leverage, free cash flow, diversification and firm performance. 73 iv LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com LIST OF TABLES Table 2. 1: Summary the previous theories and studies.
2: Variable descriptive statistics. 3: Spearman and Pearson correlation. 1: Results of regression equations of firm performance (eq. 2: Results of regression equations free cash flow (eq.
3: Results of regression equations related entropy (eq. 4: Results of regression equations unrelated entropy (eq. 5: Results of regression equation debt leverage (eq. 60 v LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com LIST OF FIGURES Figure 2.
1: Summary of separate research related to capital structure, free cash flow, diversification and firm performance. 2: Holistic framework for capital structure, free cash flow, diversification and firm performance .1: Number of companies which devided by diversified types and stock exchange .1: Inter – relationship among leverage, free cash flow, related diversification and firm performance .2: Inter – relationship among leverage, free cash flow, unrelated diversification and firm performance. 63 vi LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com CHAPTER 1: INTRODUCTION 1. Motivation of the research Vietnam is one of the few countries that was less affected by the global financial crisis in 2008, and is said to still maintain economic growth in a positive way.
However, more or less, Vietnam is yet not able to avoid the negative impacts of this financial crisis storm; as the panorama of Vietnam’s economy has recently deteriorated and started to slow down. In addition, the public – debt crisis in Europe also contributed to the growth of our country's GDP with the GDP in the period after 2008 much lower than the pre - crisis one. According to the General Statistics Office of Vietnam, Vietnam’s GDP in 2014 increased by 5.98%, compared to this indicator in 2007, which was 8. Besides, the high inflation rate leads to tight monetary policy of central banks, meanwhile, the sudden increase of lending rates has brought about numerous difficulties to the firms in raising capital to expand their either production or investment for potential new projects In this situation, the Vietnamese firms have become the most serious “victims” which were negatively influenced by the financial crisis and public - debt crisis in Europe.
Manufacturing and business suffered from the pressure resulting from the economic and political instability worldwide as well as domestic such as the existence of bad debts, the difficulties in goods consuming, or the ability of fund disbursement was still low, etc. In recent years, a number of companies failed to continue operations because of daily losses, ended up bankruptcy. In this tough situation, many companies needed to change to survive. These companies have chosen to restructure the capital structure, or invest in other factors to minimize business risks, as well as have verity production, etc.
Whether implementing any business strategies, companies’ top priority is focused on improving firm performance, withstanding and overcome the crisis repercussion. Therefore, which factors and how they impact on firm performance are the most essential points that companies need to pay attention to. 1 LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com There have been multiple studies aimed for finding out exactly what factors and these factors’ effects on the firm performance, and one of the most highlighted directions is the consideration of the change in firm performance in relation to free cash flow, capital structure, and firm diversification. Many economists have pointed out there is a strong correlation between these factors, but how they interact with each other was still a controversy.
Modigliani and Miller (1958) argued that capital structure did not affect the firm value, but in the author’s own study in 1963, the authors confirmed the firm value could be determined by the capital structure of company. Tang and Jang (2007) with the trade – off theory between equity and debt, or Myers and Majluf (1984) with pecking - order theory. also had the valuable research on the relationship between capital structure and firm performance. The relationship between leverage and diversification was also analyzed in the studies by Taylor and Lowe (1995), Kochhar and Hitt (1998), Markides and Williamson (1996) and La Rocca et al.
However, the comprehensive study of the relationship between these four factors was still limited and the problem has not been fully exploited. Capital structure, free cash flow, diversification and firm performance have important implications in the survival and development of companies. Therefore, the results of this study may be helpful for companies listed on the stock market in particular and Vietnamese companies in general in determining the proper capital structure, in line with long-term orientation of company, or using the cash sensibly, avoiding the cash holding expense while still maintaining the ability to invest in potential new projects. Moreover, the clarification of the relationship between diversification and firm performance would be useful for companies in the implementation of diversification strategies in production or business.
In the world in general and Vietnam in particular, there were a lot of studies which research the relationship between capital structure and business results in the company, but the relationship between these factors with the diversification has not yet been extensively researched, therefor this research focused on the inter-relationship between 2 LUAN VAN CHAT LUONG download : add luanvanchat@agmail.com capitalstructure, free cash flow, diversification and firm performance, research and find out whether there are any relationship in a holistic situation among these factors in Vietnamese companies. Research objectives In order to find out the relationships between firm performance, capital structure, free cash flow and diversification, the study focus on two goals basically: 1, Examine the single relationships of the four factors: capital structure, free cash flow, diversification and firm performance of companies in Vietnam. 2, Consider these relationships in a holistic situation. The study poses the following questions in order to serve the research objectives: 1, Whether the capital structure, free cash flow, diversification and firm performance have the relationships with each? 2, Whether the relationship of these four factors change when they are put into the relationships with financial factors and the company's strategy? 1.
Research contribution For the companies, the relationship among the four factors of firm performance, capital structure, free cash flow and diversification is one of the leading concerns. Therefore, the study about these factors in the binding relationship has an important meaning. An optimal capital structure can help companies maximize firm value, ensure immediate investment capacity while reduce the risk of bankruptcy.