Growth option and capital structure: Evidence from an emerging markets

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GROWTH OPTION AND CAPITAL STRUCTURE: 
EVIDENCE FROM AN EMERGING MARKETS 
ThS. Nguyễn Công Thành 
Department of Economics & Finance - School of Business & Management 
RMIT University Vietnam 
TS. Nguyễn Phúc Cảnh 
Deputy Editor-in-Chief, Journal of Economic Development (JED) 
Trƣờng Đại học Kinh tế Tp. HCM 
ThS. Phạm Thị Anh Thƣ 
School of Economics, University of Rennes 1 
Abstract 
This study examines the impacts of firm growth opportunities on capital structure of 
Vietnamese firms. By employing Pooled Ordinary Least Squared (POLS), Fixed Effects 
Models (FEM) and Random Effects Models (REM) techniques for balance panel data, we 
find significant statistic evidences supporting for pecking order theory which defines the 
positive effects of growth option on capital structure. Interestingly, we find that capital 
structure is positively affected by tangibility, but this effect appears to be a consequence of 
the impact of tangibility on long-term debt rather than short-term debt. 
Keywords: capital structure, growth option, emerging markets, pecking order theory, 
trade-off theory. 
JEL classifications: G31, G34. 
1. Introduction 
In the financial literature, the relationships between capital structure and growth 
options are explained in two main theories including trade – off theory and pecking – order 
theory. Numerous studies have been done to examine the relationships between capital 
structure and growth option in the economic field of finance and capital analysis following 
these theories (for instance, see Adedeji (2002), Antoniou et al. (2008), Antoniou et al. 
(2008), and Antoniou et al. (2008)). In fact, these empirical works on the capital structure and 
growth options under the light of trade – off theory and pecking – order theory have been 
taken in the context of developed countries such as US, Japan, UK, which have strong market 
disciplines, corporate governance and less agency problems (Harford et al., 2012). 
Some recent studies consider these theories in the context of emerging countries such 
as China with the results favor the existence of pecking – order theory. For example, Chen 
(2004) finds that neither the trade-off model nor the Pecking order hypothesis derived from 
the Western settings provides convincing explanations for the capital choices of the Chinese 
firms. Where, the capital choice decision of Chinese firms seems to follow a „„new Pecking 
order‟-retained profit, equity, and long-term debt, this is because the fundamental institutional 
assumptions underpinning the Western models are not valid in China. Tong and Green (2005) 
find a significant negative correlation between leverage and profitability, and a significant 
positive correlation between current leverage and past dividends, that results broadly support 
the pecking order hypothesis over trade-off theory in Chinese companies. Yao-hui and Yuan-
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lue (2007) use independent variable order property of ordered-probit model, their findings 
support the pecking order theory as far as exterior financing order of Chinese companies. Ni 
and Yu (2008) examine whether the financial structure of China's listed companies follows a 
pecking order from debt to equity, they find no evidence that China's listed companies follow 
a pecking order when they need funds to finance investment projects. More precisely, they 
indicate that big companies follow a pecking order and small and medium companies do not, 
this result suggests that the Chinese capital market is still under development. 
Moreover, the turbulences of the 2008 global financial crisis have revised the attention 
to the relationships between growth options and financial leverages in emerging markets, 
especially in a small one such as Vietnam, which is suffered from a hardship period from 
2008 to 2012 with many cases of firm‟s bankruptcy and problem in banking system (Vo and 
Nguyen, 2014). In addition, the stock market of Vietnam has been developed from the 
beginning of 2000 (Vo and Nguyen, 2016), which creates new channel for Vietnamese firms 
in choosing funds for their projects besides the loans from commercial banks as the traditional 
way, therefore the behaviors of Vietnamese firms may be impacted. Therefore, this study fills 
the gap of financial literature by examining the relationship between growth options and 
financial structure of 261 Vietnamese firms in the period of 2008 – 2015. 
By using the estimation techniques for balance panel data, this study firstly estimates 
the relationship between growth options and financial leverages of Vietnamese firms, then we 
divide the data into two sub-periods: the period from 2008 to 2011 which presents for the 
period of crisis, and the period from 2012 to 2015 which presents for the period of post – 
crisis. The rest of this study is organized as following manners. Section 2 presents ... , Growth Opportunities 
measured by MB and other explanatory variables excluding Tangibility have significantly 
positive impact on leverage with respect to total debt and short-term debt. In addition, None 
Debt Tax Shield once again tends to have more obviously positive effects on Short-term Debt 
and negative on Long-term Debt after financial crisis based on evidences of POLS and 
random effects model. From the one side, tangible asset displays significantly negative impact 
on short-term debt. From the other side, tangibility demonstrates opposite effects on long-
term debt. 
Another point to note is that Size and average industry leverage almost perform 
significantly impact on either short-term or long-term debt in all cases. Nonetheless, the 
effects of average industry leverage on Long-term Debt are found to be insignificant in both 
fixed effects and random effects technique. It is claimed that the impact of the inverse 
exponential of MB on leverage become more visible compare to MB due to prominent R
2
 and 
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adjusted R
2
 in almost cases. The final important fact is that Wald chi-squared and F-Statistics 
are demonstrated to be significant in any cases throughout the three technique involving 
POLS, Fixed Effects Model and Random Effects Model. As a consequence, all null 
hypothesis of zero estimated coefficients in all cases are rejected then an indirect conclusion 
could be make is that all estimations are suitable with provided dataset. 
Table 12. Parameters Test, Hausman Test and Breusch & Pagan Lagrange multiplier Test. 
TDTA 
MB INVEPX. MB 
2008 - 2015 2008 - 2011 2012 - 2015 2008 - 2015 2008 - 2011 2012 - 2015 
POLS vs FE 
F-Statistic 32.39*** 26.74*** 28.12*** 36.95*** 29.03*** 31.24*** 
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 
RE vs FE 
Chi
2 
72.51*** 53.91*** 01.92*** 79.97*** 54.07*** 76.68*** 
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 
POLS vs RE 
Chibar
2 
2991.*** 947.1*** 536.2*** 3083.*** 967.5*** 545.0*** 
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 
STDTA 
POLS vs FE 
F-Statistic 23.12*** 15.74*** 23.25*** 24.42*** 16.49*** 24.52*** 
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 
RE vs FE 
Chi
2 
77.04*** 44.92*** 23.06*** 73.99*** 40.34*** 17.48*** 
Prob. 0.000 -0.000 -0.000 0.000 0.000 0.000 
POLS vs RE 
Chibar
2 
2558.*** 803.0*** 530.6*** 2613.*** 827.0*** 533.4*** 
Prob. 0.000 0.000 -0.000 0.000 0.000 0.000 
LTDTA 
POLS vs FE 
F-Statistic 17.41*** 15.58*** 15.60*** 17.36*** 15.36*** 15.15*** 
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 
RE vs FE 
Chi
2 
19.62*** 21.87*** 42.23*** 20.92*** 26.66*** 32.41*** 
Prob. 0.002 0.001 0.000 0.001 0.000 0.000 
POLS vs RE 
Chibar
2 
2229.*** 798.7*** 459.3*** 2209.*** 782.1*** 461.1*** 
Prob. 0.000 0.000 0.000 0.000 0.000 0.000 
*, **, *** respectively denotes significance level of 10%, 5%, 1% 
Source: Author’s estimation 
From a particular point of view using a combination of the three given test, the results 
appear to be encouraged to base on Fixed Effects Model. To be more precise, the core of 
parameters test is to check whether coefficients of all dummy variables represented for firm-
specific equal to zero. The results are found to reject the null-hypothesis then firm-specific 
seems to exist in collected dataset. The results of Hausman test appeared to reject the null 
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hypothesis that coefficients estimated by fixed effects technique are equaled to those 
estimated by random effects technique. Hence, fixed effects model tends to give a more 
persistent result. The heart of final test is to check for variance of firm-specific characteristics 
equals to zero. Consequently, rejecting null hypothesis leads to the result that POLS may face 
with bios regression because the average of error term different from zero. 
5. Conclusions 
There are solid evidences that Growth Opportunities demonstrate significantly positive 
impact on Leverage in most of the cases including Short-term Debt to Total Asset, Long-term 
Debt to Total Asset. Even in the period of the world financial crisis or after the crisis, the 
effects of Growth Opportunities on leverage usually appear to be significantly positive. 
Therefore, Pecking order theory seems to be supported in our study case. However, this effect 
seems to imply more obvious on Short-term Debt rather than Long-term Debt. Moreover, this 
study also found little evidence of negative effects of Growth Opportunities on Long-term 
Debt after the financial crisis. More importantly, many substantial evidence disclose the 
information that Growth Opportunities comes into sight to have non-linear impact on 
Leverage in either short-term or long-term debt. 
 Tangible asset tends to have negative effects on short-term debt and positive effects 
on long-term debt. Especially, the impact of Tangibility seems to be clarified after crisis 
period. Nevertheless, the effects of None Debt Tax Shield appear to have positive influence 
on short-term debt and negative effect on long-term debt. In contrary, the positive impacts of 
Size and average Industry Leverage are found to be consistent because these effects are 
significant in most of cases. However, the influence of average Industry Leverage on long-
term debt is not found to be significant after financial crisis period. In general, a combination 
of provided evidence in this study seems to support the pecking other theory base in Vietnam 
Market database in the period of 2008 – 2015. 
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