Firm's histories, managerial entrenchment and leverage ratio from Vietnam's listed firms

Abstract

Corporate governance principles provide the framework for firms to achieve their objectives. The framework is generally considered as the interactions between management, board, and shareholders. Fundamental theories and findings from empirical studies primarily indicate that strong corporate governance successfully promotes a business success in relation to both management and finance by reducing agency conflict and achieving an optimal level of capital structure. The effect of corporate governance on capital structure has been raised and investigated in various empirical studies for an extended period of time. Within the corporate governance framework, the relationship between managerial entrenchment and leverage ratio has attracted great attention from academia, practitioners, and policy makers from developed world. However, this important link has not been sufficiently considered and investigated in the context of developing nations, including Vietnam. Using a sample of 289 non-financial firms listed on Ho Chi Minh Stock Exchange during the period 2006-2015, this study is conducted to provide two major pieces of empirical evidence to fill the following gaps in current research of corporate governance in the Vietnamese context. First, for the first time in Vietnam, the effect of corporate governance, managerial entrenchment, together with the market timing behavior on leverage ratio is considered. In this study, managerial entrenchment is proxied by block-holder holdings, board size, director age, CEO-Chairman duality, board composition, and CEO age. Also, market timing behavior is represented by firms’ histories on leverage ratio which is measured by the ratio between book leverage and market leverage. Second, the impact of managerial entrenchment on firm’s leverage ratio is then classified into two distinct regimes, including a high entrenchment regime and a low entrenchment regime. Furthermore, a two-stage approach is used in this study: (i) to determine the target leverage level; and (ii) to quantify the effects of managerial entrenchment and firms’ histories on the observed leverage level of listed firms in Vietnam. Variety econometric techniques, along with the traditional Ordinary Least Squares (OLS) method, are incorporated such as the Generalized Method of Moments (GMM) and endogenous switching regression method. Key findings achieved from this study can be summarized as follows. First, empirical evidence indicates that there is a negative relationship between managerial entrenchment and leverage ratio. Findings from this study confirm the view that entrenched managers’ decision to reduce a leverage ratio by issuing equity is consistent with market timing behavior. Second, the results achieved from the study demonstrate that a negative effect of firms’ histories including financial deficit and various timing measures together with stock price histories on leverage ratio of Vietnam’s listed firms is found over the research period. Third, the impact of high managerial entrenchment regime and low managerial entrenchment regime and firms’ histories on book leverage ratio and market leverage ratio is found in this study. The results confirm that high-entrenched managers pay attention on the market timing and benefit from the equity market. As a result, they reduce a leverage ratio utilized in their firms. Fourth, the results present that the high managerial entrenchment regime is in relation to larger number of block-holders, larger boards, older CEOs with CEO-Chairman duality and more outside directors. Fifth, findings from this study also reveal empirical evidence to support the view that the change of leverage ratio is a negative response to financial deficit, profitability, timing measures – yearly timing and long-term timing and an alternative timing measure – insider sales, and stock price returns. Considerably, the downward adjustment of debt ratio results from the high managerial entrenchment effect. Sixth, high authority of entrenched managers to the board could be linked to weak corporate governance in the Vietnamese context. This observation is based on the reports of International Finance Corporation and the State Securities Commission Vietnam (2006) and International Finance Corporation and the State Securities Commission Vietnam (2012).