Firms’ investment – cash flow relationship in the context of state ownership and banking system reform in Vietnam

Tsai et al. (2014) in their study on effect of bank system reform

on investment – cash flow sensitivity measures banking system reform

by presence of foreign bank at region where company had

headquartered or branches. The research finds evidence that with

presence of foreign banks, politically-oriented investments at state

controlled listed companies are reduced because state-owned banks

transform from more politically – oriented to more commercially –

oriented financing.

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ut most of them use the samples of developed countries like U.S, Canada, or China – a big transitional economy. To my best knowledge, the relationship between investment and cash flows, especially in the context of state – ownership and foreign bank entry has still not investigated for the case of a small transition economy like Vietnam. Furthermore, in spite of sharing some cutural, social and political similarities with China, Vietnam also has many differences such as size of economy, history of the transformation, openness to the world economy, development of financial market, etc. Studying the Vietnamese context is believed to be worthwhile and valuable for international finance literatures because results form the rather specific case of China may not be generalizable for other small emerging markets. Therefore, I choose to examine the impact of banking system reform, and state ownership on investment – cash flow sensitivity in Vietnam for my Ph.D thesis. 4 The thesis follows the series of essays format which consists of two independent essays: Firm’s investment – cash flow relationship in the context of state ownership in Vietnam; and Firm’s investment – cash flow relationship in the context of banking system reform in Vietnam. 1.2. Thesis objectives: The thesis aims to investigate the impact of state ownership and banking system reform on the relationship between firm’s investment and internal cash flows in the context of small transition economy – Vietnam. 1.3. Methodology: The study applies quantitative method on non-balanced panel samples of Vietnamese listed firms which are extracted from the Thomson Reuters database and manually collected from companies’ annual reports. All the regressions are estimated by Generalized Least Squared (GLS) method to fix the heteroscedasticity problem and robusted by Generalized Method of Moment (GMM) for endogeneitity potential. 1.4. Empirical findings The results show that the investment–cash flow relation for both state-owned and non-state-owned firms is U-shaped. In addition, state-owned companies have higher cash flow sensitivity of investment, which perhaps is due to their socioeconomic and political responsibilities, poor corporate governance and agency problem. Also, presence of foreign banks in Vietnam results in a decrease in investment cash flow sensitivities of Vietnamese companies. Although overinvestment of state controlled firms is not reduced but 5 underinvestment problem of non- state -controlled listed firms is mitigated due to better accessibility to bank loans with presence of foreign banks. 1.5. Contributions The studies provides evidences on the non-linear relationship between investment and cash flows in Vietnam, which have been under-investigated. More importantly, it sheds further light on the implications of financial constraints on investment under the impact of state ownership and banking system reform, especially in a small transitional economy such as Vietnam. Therefore, the study results can be helpful reference for policy makers, managers, economic and business lecturers and students. Chapter 2 FIRM’S INVESTMENT – CASH FLOW RELATIONSHIP IN THE CONTEXT OF STATE OWNERSHIP CONTROL IN VIETNAM 2.1. Study motivations This chapter presents the first essay: a study on firm’s investment - cash flows relationship under the context of state ownership control in Vietnam. The study is motivated by the domination of state ownership in Vietnamese companies while its impact on firm performance as well as financial decisions have still been unconsistent in the literature. Otherwise, from our best knowledge, little attention to date has been paid to the impact of state ownership on the investment–cash flow relation, especially in a small transitional economy such as Vietnam. 6 2.2. Literature review and hypothesis development 2.2.1. Relation between investment and cash flow Fazzari et al. (1988) is the first person who show the linear relationship between investment and cash flow by using a sample of US manufacturing firms in the period 1970–1984. The authors also evidence find that the relation is more sensitive at financially constrained firms and less sensitive at non-financially constrained firms. The linear relationship also supported by Hoshi, Kashyap, and Scharfstein (1991); Kaplan and Zingales (1997); Cleary (1999) and Almeida and Campello (2007). However, Cleary et al. (2007) find a U-shaped relation, which is caused by cost and revenue effects, between investment and cash flow. The cost effect arises because when firms invest more, their borrowing cost rises. The authors conclude that firm’s investment has a positive relation with internal cash flows when the cash flows are significant, and a negative relation if they are low. The U-shape is also supported by Guariglia (2008). Additionally, beside comfirming the non-linear curve, Firth et al. (2012) further argue that the curve may vary with politically oriented investment or a soft budget constraint. Tsai et al. (2014) assert the flatter U-shaped curves with the presence of foreign banks, which reduce financial constraints for firms, especially those that are privately owned. This means that lower investment - cash flow sensitivity reduces underinvestment by listed SOEs. The U-shaped relation between investment and cash flow may be explained as follows. The small and young companies normally have low range of cash flows and good investment opportunities, 7 which are well perceived by the market, so these companies are easier to raise external capital from financial market, resulting in a negative investment – cash flow relation. However, having no current investments, higher cash flows will not materialize in the future. Therefore, it is not a feasible strategy to coincide timing investment with high cash flow period (Hovakimian, 2009). This argument also supports the argument by Cleary et al. (2007) with cost – revenue effect explanation. Therefore I expect that Vietnamese firms have a similar investment–cash flow relationship, so the following hypothesis is set: H2.1: The investment and cash flow relation at Vietnamese companies is U-shaped. 2.2.2. State Ownership and Investment–Cash Flow Relations Many studies have been conducted on the impact of soft budget constraints on the relationship between cash flow and investment. Early research by Chow and Fung (1998) finds evidence that investment by private firms has higher cash flow sensitivity than that by SOEs, implying that the latter face fewer financial constraints than non-SOEs. Héricourt and Poncet (2009), as well as Poncet, Steingress, and Vandenbussche (2010) arrive at similar conclusions. According to Cleary et al. (2007), the less financially constrained a firm is, the flatter its U-shaped curve is, as company investment is less dependent on internal cash flow. Guariglia, Liu, and Song (2011) find that SOEs’ asset growth is not affected by liquidity constraints, while the availability of internal funds constrains the growth potential of private companies. The soft budget constraints at SOEs are due to their social and political responsibilities (Bai, Lu, & Tao, 2006; C. R. Chen, Li, 8 Luo, & Zhang, 2017a; J. Y. Lin & Tan, 1999; Sheshinski & López- Calva, 2003). On the contrary, Firth et al. (2012) show that SOEs have a steeper U-shaped curve than private firms, especially on the left- hand side of the curve. The findings appear to contradict the argument on SOEs’ soft budget constraints. The authors argue that Chinese SOEs are induced by the government to use their own cash flows to invest more, so as to achieve multiple government socioeconomic objectives when they have abundant internal cash flows and when they face negative internal funds. In Vietnam, SOEs also have responsibilities to fulfil government socioeconomic and political objectives as the Chinese ones. The SOEs, under the government influences in many cases, have to undertake some assigned, even negative net present value (NPV) investments, leading to overinvestment problems. However, unlike the private firms, the Vietnamese SOEs do not associate investments with firm’s fundamentals (O'Toole, Morgenroth, & Ha, 2016), indicative of poor investment efficiency. R. Chen, El Ghoul, Guedhami, and Wang (2017b) also report that SOEs’ investments have lower efficiencies than non SOEs do. Lower efficiency may cause a higher cost of external financing, which in turn make SOEs have more reliance on the internal capital. Therefore, the following hypothesis is posited: H2.2: SOEs have higher investment–cash flow sensitivity. 2.2.3. State Ownership and Investment–Leverage Relation In literature, a negative relation between debt and investment are found by many studies (Aivazian, Ge, & Qiu, 2005; Firth, Lin, & Wong, 2008; Jensen, 1986; Lang, Ofek, & Stulz, 1996; Myers, 1977). On the other side, as indicated in many studies (Chow & Fung, 1998; 9 Guariglia et al., 2011; Héricourt & Poncet, 2009; J. Y. Lin & Tan, 1999; Poncet et al., 2010), SOEs have a soft budget constraint, which means they can easily access external financing (Allen et al., 2005; Cull, Li, Sun, & Xu, 2015; Cull & Xu, 2003). Nhung and Okuda (2015) also point that Vietnamese SOEs have easier access than other firms when borrowing funds from banks and making profits, even after an economic boom. As such, state ownership may have certain impact on the relation between investment and leverage. Therefore, the thesis also investigate the impact of state ownership on investment–leverage relations by developing the following hypothesis: H2.3: State ownership has a positive impact on a firm’s investment–leverage relations. 2.3. Research design 2.3.1. Testing Investment–Cash Flow Relation In order to test the U-shape relationship, in this study, two different approaches to examine investment–cash flow relations, using the basic model of investment developed by Fazzari et al. (1988) are employed as follows: In the first approach, CFKSQRi,t is added into the basic model as employed by Cleary et al. (2007); Firth et al. (2012): 𝐼𝐾𝑖,𝑡 = 𝛼0 + 𝛼1𝐶𝐹𝐾𝑖,𝑡 + 𝛼2𝐶𝐹𝐾𝑆𝑄𝑅𝑖,𝑡 + 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠𝑖,𝑡 + 𝑣𝑖 + 𝑣𝑡+ 𝑒𝑖,𝑡 (2.1) where i and t are firm and time, respectively; vi is the firm-fixed effects; vt is the year-fixed effects, and eit is the error term. IKit is the investment ratio. CFKi,t is the annual internal cash flow ratio. Controls is a vector of control variables that potentially affect firm investment, including the SGi,t-1 (firm’s sales growth); SIZE (firm size); LEVi, t-1 (financial leverage); AGEi,t (firm age); BETAi,t (beta coefficient). 10 In the second approach, following Firth et al. (2012), the cash flow (CFK) of the basic model is separated into positive cash flow (CFKPOS) and negative cash flow (CFKNEG) by using the dummy variables POS and NEG. POS takes a value of 1 if CFK is greater than 0, and 0 otherwise. Similarly, NEG takes a value of 1 if CFK is less than 0, and 0 otherwise. 𝐼𝐾𝑖,𝑡 = 𝛼0 + 𝛼1𝐶𝐹𝐾𝑃𝑂𝑆𝑖,𝑡 + 𝛼2𝐶𝐹𝐾𝑁𝐸𝐺𝑖,𝑡 + 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠𝑖,𝑡 + 𝑣𝑖 + 𝑣𝑡 + 𝑒𝑖,𝑡 (2.2) A significant change in the sign of the coefficients of CFKPOS and CFKNEG shows a nonlinear relation between investment and cash flows. A U-shaped curve has a significantly positive sign for CFKPOS and significantly negative sign for CFKNEG. An inverse-U-shaped curve has a significantly negative sign for CFKPOS and significantly positive sign for CFKNEG. 2.3.2. Testing the impact of state ownership on investment–cash Flow Relations To test the impact of state ownership on investment–cash flow relations, I use two different proxies for state ownership (SC):  First, SC (= STATE) is measured by a dummy variable that takes a value of 1 if the percentage of state ownership in firm i in year t is at least 50% of total voting shares and 0 otherwise. This method compares the investment behavior of two groups: state-owned (SOEs) and non state-owned (non-SOEs) firms.  Second, SC (= GOV) is measured by the percentage of state ownership in firm i in year t. This method measures the extent of government influence on firm investment behavior. The two SC proxies are sequently interacted with CFKPOS and CFKNEG. The regression model is as follows: 11 𝐼𝐾𝑖,𝑡 = 𝛼0 + 𝛼1𝐶𝐹𝐾𝑃𝑂𝑆𝐼,𝑡 + 𝛼2𝐶𝐹𝐾𝑁𝐸𝐺𝐼,𝑡 + 𝛼3𝐶𝐹𝐾𝑃𝑂𝑆_𝑆𝐶𝐼,𝑡 + 𝛼4𝐶𝐹𝐾𝑁𝐸𝐺_𝑆𝐶𝐼,𝑡 + 𝛼5𝑆𝐶𝐼,𝑡 + 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠𝑖,𝑡 + 𝑣𝑖 + 𝑣𝑡 + 𝜀𝑖,𝑡 (2.3) 2.3.3. Testing the impact of state ownership on investment–leverage relations The following model is used to test H2.3. Two different proxies for state ownership (SC) described in section 2.3.2 are used to interact with leverage (LEV) as follows: 𝐼𝐾𝑖,𝑡 = 𝛼0 + 𝛼1𝐶𝐹𝐾𝑖,𝑡 + 𝛼2𝐿𝐸𝑉𝑖,𝑡−1 + 𝛼3𝑆𝐶𝑖,𝑡 + 𝛼4𝑆𝐶𝑖,𝑡 ∗ 𝐿𝐸𝑉𝑖,𝑡−1 + 𝐶𝑜𝑛𝑡𝑟𝑜𝑙𝑠𝑖,𝑡 + 𝑣𝑖 + 𝑣𝑡 + 𝜀𝑖,𝑡 (2.4) All the tests are conducted for full-sample, SOEs and non SOEs subsamples, and high growth and low growth subsamples. 2.3.4. Data An unbalanced panel data in 2009-2015 for non-financial companies listed on the HOSE and the HNX is used. Both financial and market data are extracted from the Thomson Reuters database. Observations with missing data are omitted, and outliers that may influence the results are also excluded by winsorizing 1% of the two tails for each variable. 2.4. Summary of the study results The study investigates the impact of state ownership on the relation between investment and cash flow in Vietnam, a small transition economy. The results also show higher cash flow sensitivity of investment at SOEs, implying higher financial contraints, compared with non-SOEs because the former have social and political responsibilities. At SOEs, sensitivity is higher when cash flows are positive than when cash flows are negative. Our results also show that privately owned companies increase investment more when they have 12 a positive rather than negative cash flow, but the investment behavior of state-owned companies is the opposite. They reduce investment more when they have negative cash flow than when cash flow is positive. Furthermore, the study finds that bigger as well as riskier companies make less investment than smaller or less risky ones. Table 4.4. Summary of regression result testing the U-shape investment and cash flow relation Panel A: Regression with square of cash flow (CFKSQR) Full sample State-owned enterprises Non-state-owned enterprises CFK 0.002*** -0.005 0.002*** (2.69) (-0.64) (2.87) CFKSQR 0.00001*** 0.002*** 0.00001*** (34.72) (7.43) (34.06) Panel B: Regressions separating CFK into CFKPOS and CFKNEG Full sample State-owned enterprises Non-state-owned enterprises CFKPOS b1 0.026*** 0.067*** 0.026*** (16.95) (15.00) (20.56) CFKNEG b2 -0.002 -0.105*** 0.0005 (-1.42) (-6.18) (0.64) joint test (b1=b2) 0.000 0.000 0.000 R-sq. 0.564 0.498 0.562 Fixed Effect Year and Industry Year and Industry Year and Industry No. of Obs. 2734 773 1961 Different investment behaviours are found by companies with high versus low growth opportunity. Investment by both SOE and non- SOE high growth companies is less dependent on internal cash flow. High growth SOEs have higher cash flow sensitivity of investment than non-SOEs. However, low growth SOEs have higher cash flow sensitivity of investment than non-SOEs, suggesting that the social and political investments by the former may be inefficient. 13 Table 4.5: Impact of state ownership on investment – cash flow relations SC = STATE SC = GOV CFKPOS b1 0.0234*** 0.028*** (15.24) (24.47) CFKNEG b2 0.00005 0.002*** (0.07) (8.27) CFKPOS_SC b3 0.048*** -0.029*** (7.28) (-7.63) CFKNEG_SC b4 -0.119*** -0.039** (-13.52) (-2.28) SC 0.015 0.029 (1.21) (1.36) Joint test (p-value) b1=b2 0.000 0.000 b1+b3=0 0.000 0.668 b2+b4=0 0.000 0.029 b1+ b3=b2+b4 0.000 0.037 R-sq. 0.570 0.572 Fixed Effect Year and Industry Year and Industry No. of obs. 2734 2734 Moreover, I also find that previous-period leverage has a positive effect on SOEs. High growth SOEs have a soft budget constraint, but both high growth non-SOEs and low growth SOEs are more reliant on internal cash flows to finance their investments. Our study provides additional evidence on the impact of state ownership on corporate investment–cash flow relations, especially in a small transition economy, which may be useful for future research on a similar topic in a similar context. However, the research only investigate the impact of the Vietnam’s state ownership among various forms of ownership, which could be further exploited in future studies, on the investment- cash flow relation. 14 Chapter 3 FIRM’S INVESTMENT – CASH FLOW RELATIONSHIP UNDER THE CONTEXT OF BANKING SYSTEM REFORM IN VIETNAM 3.1. Study motivation: This study examines the effect of banking system reform which is measured by foreign bank’s presence on investment-cash flow relation in a context of a small transition economy. The study is motivated by the fact that in Vietnam, financial system has been going through many reforms to improve its efficiency as well as to integrate into the world economy, including accepting the presence of foreign banks. Tsai et al. (2014) document that presence of foreign banks would reduce corporate investment-cash flow sensitivities in China. To my best knowledge, there is quite few studies on this topic. So, case of China may not be generalized for other small developing countries with unmature financial market like Vietnam although Vietnam shares some political, cultural, social and economic similarities with China. 3.2. Literature review Among studies on impact of foreign banks, Detragiache, Tressel, and Gupta (2008) find evidence that foreign banks are less sensitive to political pressure, and they have less pressure of lending relation partners, who are capable of breaking relation barriers. Political and non-economic motivations are not top priorities of domestic banks now. Therefore, state-owned commercial banks are transformed from politically – incentive organization to modern corporate governance – oriented ones. Therefore, reforming bank 15 system by allowing foreign banks holding ownership at domestic state-owned banks could reduce policies favoring politically – oriented investments of state – controlled companies. With presence of foreign investors, credit granting would be more prudential, in that way careless loans as well as politically-oriented loans could be mitigated. With this research, Detragiache et al. (2008) use foreign ownership in domestic bank as proxy for banking system reform and this research is supported by Berger, Klapper, Peria, and Zaidi (2008). Berger et al. (2008) report that after reform, foreign ownership in domestic banks, especially state-controlled banks can change their lending practice, from politically – oriented to commercially-oriented banks. Non state-controlled listed companies are considered more transparent, more commercially-oriented and more efficient than state-controlled listed companies. Therefore, after reform, non-state- controlled listed companies have more channels to access bank loan and underinvestment problem of non-state- controlled listed companies are reduced. Tsai et al. (2014) in their study on effect of bank system reform on investment – cash flow sensitivity measures banking system reform by presence of foreign bank at region where company had headquartered or branches. The research finds evidence that with presence of foreign banks, politically-oriented investments at state controlled listed companies are reduced because state-owned banks transform from more politically – oriented to more commercially – oriented financing. Problem of underinvestment at non state – controlled listed companies seems to be mitigated due to an increase in their bank loan accessibility. The study also documents a reduction 16 of distortion of investment in state controlled listed companies as well as reduction on financial constraints at non state – controlled listed companies. 3.3. Research methodology 3.3.1. Hypothesis development and model specification 3.3.1.1. Effect of banking system reform on investment–cash flow relation It is common to have problem of “flexible” budget constrain in the centrally-planned economy, which refers to the favorable policies for state-controlled organizations. Due to being owned by government, these organizations are often bailed out if they are in trouble, normally in form of subsidy, tax deduction or exemption, set low input cost, set high output price, low cost financing, etc. Therefore, state – owned enterprises in Vietnam normally can access bank credit much easier and normally at lower cost than private ones, that leads to the situation of overinvestment. Moreover, like China, overinvestment problem in state-controlled companies are mainly caused by politically- oriented investments (Firth et al., 2012) because officials in these companies also have incentives to achieve social and political objectives for their promotion (Liu & Lu, 2007). Meanwhile, non-state-controlled companies are not favored with these privileges, so they have to rely on their own internal cash flow to finance their investment opportunities (Tsai et al., 2014). With the presence of foreign bank, credit market become more competitive and transparent. State-owned banks may have to change its lending practices from politically-oriented to commercially- oriented, so non-state controlled companies have more chance to 17 access bank financing, so underinvestment problem of these company could be reduced. H3.1: Banking system reform mitigates overinvestment problem at state – controlled companies H3.2: Banking system reform mitigates underinvestment problem at non state – controlled companies Following Firth et al. (2012), the impact of foreign bank presence on investment cash flow sensitivity is tested by following model: 𝐼𝐾𝑖,𝑡 = 𝛼0 + 𝛼1𝐶𝐹𝐾𝑃𝑂𝑆𝐼,𝑡 + 𝛼2𝐶𝐹𝐾𝑁𝐸𝐺𝐼,𝑡 + 𝛼3𝐶𝐹𝐾𝑃𝑂𝑆𝐵𝐴𝑁𝐾𝐼,𝑡 + 𝛼4𝐶𝐹𝐾𝑁𝐸𝐺𝐵𝐴𝑁𝐾𝐼,𝑡 + 𝛼5𝐵𝐴𝑁𝐾𝐼,𝑡 + 𝛼6𝑆𝑎𝑙𝑒𝑠𝐺𝑟𝑜𝑤𝑡ℎ𝑖,𝑡−1 + 𝛼7𝑆𝐼𝑍𝐸𝑖,𝑡 + 𝛼8𝐿𝐸𝑉𝑖,𝑡 + 𝛼9𝐴𝐺𝐸𝑖,𝑡 + 𝛼10𝐵𝐸𝑇𝐴𝑖,𝑡 + 𝑣𝑖 + 𝑣𝑡 + 𝜀𝑖,𝑡 (3.1) where i and t are firm and time, respectively; vi is the firm-fixed effects; vt is the year-fixed effects, and eit is the error term. IKit is the investment ratio. CFKi,t is the annual internal cash flow ratio. Controls is a vector of control variables that potentially affect firm investment, including the SalesGrowthi,t-1 (firm’s sales growth); SIZE (firm size); LEVi, t-1 (financial leverage); AGEi,t (firm age); BETAi,t (beta coefficient). POS, NEG and BANK are interaction variables which POS takes a value of 1 if CFK is greater than 0, and 0 otherwise; NEG takes a value of 1 if CFK is less than 0, and 0 otherwise. BANKi,t takes the value 1 for firms located in a region where foreign banks are allowed to do business in year t and afterwards, and 0 otherwise. 3.3.1.2. Effect of banking system reform on investment-leverage relation As many other transition economies, bank loans are still main source of external funds in Vietnam where stock market is still young 18 and immature. Moreover, presence of foreign banks provides additional credit channel for firms, resulting in mitigation of financial constraints, as well as motivation for domestic banks to improve their efficiency to be more competitive and to change lending practice to be more commercially-oriented. So, to examine if banking system reform have any impact on investment –debt relation, the following hypothesis is developed: H3.3: Banking system reform has a positive impact on firm’s investment – debt relation: Following model is used to test the hypothesis H4.3: 𝐼𝐾𝑖,𝑡 = 𝛽0 + 𝛽1𝐶𝐹𝐾𝑖,𝑡 + 𝛽2𝐿𝐸𝑉𝑖,𝑡−1 + 𝛽3𝐵𝐴𝑁𝐾𝑖,𝑡 + 𝛽4𝐵𝐴𝑁𝐾𝑖,𝑡 ∗ 𝐿𝐸𝑉𝑖,𝑡−1 + 𝛽5𝑆𝑎𝑙𝑒𝐺𝑟𝑜𝑤𝑡ℎ𝑖,𝑡−1 + 𝛽6𝑆𝐼𝑍𝐸𝑖,𝑡 + 𝑣𝑖 + 𝑣𝑡 + 𝜀𝑖,𝑡 (3.2) Definitions of other variables are as above. 3.3.2. Data The study uses an unbalanced panel data from the period 2009 to 2014 for non-financial companies listed on Ho Chi Minh City Stock Exchange (HOSE) and Hanoi

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