THE RESEARCH PROPOSAL

THE EFFECT OF DEBT CAPACITY ON

FIRMS GROWTH

STUDENT NAME:

LU NGOC HIEN

STUDENT NUMBER:

1201NB5010

COURSE NAME:

Independent Finance Study

COURSE CODE:

IFS

SUPERVISOR:

Dr. Nguyen Thi Hoang Anh

DATE OF SUBMISSION:

16/10/2015
( 2181 words)

CONTENTS
ABSTRACT .......................................................................................................................................................... 1
INTRODUCTION ................................................................................................................................................ 1
PROBLEM STATEMENT .................................................................................................................................. 3
HYPOTHESIS ........................................................................................................................................................ 3
OBJECTIVES AND AIMS .................................................................................................................................. 3
BACKGROUND AND SIGNIFICANCE ........................................................................................................... 4
RESEARCH DESIGN AND METHODS ........................................................................................................... 6
TIMEFRAMES....................................................................................................................................................... 7
OUTLINE PROPOSALS .......................................................................................................................................... 7
REFERENCES ..................................................................................................................................................... 9

ABSTRACT
The topic of the optimal capital structure is the subject of many researches. The researchers
said that businesses often operate profitably use less debt than the less profitable businesses.
The studies also showed that businesses with high growth rates also have high debt to assets
ratio and high market to book ratio. This paper considers the use of debt as a source of capital
and its impact on the development of firms. Analysing the influence of debts to asset ratio so
that recognize the positive relationship of them are the main elements of the paper. Through
collecting over 200 financial statements of 50 firms from HoChiMinh Stock Exchange, it is
easy to see that using debt as a financial leverage to promote the firms growth.

INTRODUCTION
A condition which is indispensable when establishing and conducting business is capital
structure. The mobilization of capital on the one hand has to meet the needs of capital for
production and business, but on the other hand may bear the financial risk. Therefore, to be
able to mobilize, manage and use effectively its capital, reduce financial risk, cost of capital,
the enterprise must determine for themselves a reasonable capital structure.

A tool that administrators of corporate finance may be interested in deciding the company's
capital structure that is the use of debt - financial leverage". Use the "financial leverage"
properly will increase profits for businesses significantly. And vice versa, business will have
to suffer the unavoidable risks.

Debt capacity is the ability to borrow. There is no set pattern to set the portion of debt in the
capital structure. There are different factors which company considers before taking any
decision regarding its debt. Taxes are deductible expense therefore are favourable for the
firms when tax rates are high companies move to debt to reduce the burden of taxes.

Management styles either conservative or aggressive may also be a reason which can support
company to determine its debt level. Generally firms with conservative style use less debt and
prefer equity while firms with aggressive style use more debt. Other words, when the firms
projected earnings are higher and secure, firms do not increase equity and they prefer to
finance with debt than higher earnings are reflected in stock prices.

Many factors are involved which stops them to borrow but the main factor is the growth of
the company because if the company growth is on the track, their debt level would be high
and if the company growth level is not on track then their debt level would be low. This is
consistent with the dynamic view of Pecking order theory - when company increase their debt
level there should be positive impact on growth of the firm.

Several prior studies like Cai and Zhang (2006) found that the negative effect is stronger with
high leveraged firms and also found that negative effect of leverage change the future
investment and change in long term debt affect the stock return more than the short term debt.
A. Johnson (2003) found the negative relation of debt and growth opportunities. They
discussed on short debt that also has negative impact of growth on debt and gives reason that
short debt also increases the liquidity risk that negatively affect leverage.
For maximizing firms value is the important point for every financing decision made by the
management of the company when company increase their debt capacity than another side
they are going to increase the risk factor if they do not get proper return as expected or
forecasted then it becomes very risky for company that result comes in a big loss if somehow
organizations cannot pay back their debt than company can move to liquidation or
bankruptcy.
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This paper will investigate the relationship between debt portion and the growth for
companies.

PROBLEM STATEMENT
The economic experts are very much interested in researching capital structure in recent
years. Studying capital structure helps to find a solution to the following questions:
1. How do debt capacity effect on tax shield?
2. How can company change its debt portion while maintaining its growth level?
Optimal capital structure involves trade-offs between costs and benefits of enterprise. And
two following reasons explain why the researchers believe that debt finance is cheaper than
equity. Firstly, the rights of the bondholders are taken precedence over the rights of
shareholders if business fall into bankruptcy, bondholders are considered to have a lower
level of risk to shareholders, corresponding to safety this, they will receive a rate of return is
lower than rate of profit on equity of shareholders. Secondly, interest expenses are deducted
before tax in order to reduce the income tax rate that businesses must pay, which gives
businesses tax shield benefits. Therefore, debt capacity have a significant positive impact on
firms growth.

Hypothesis
There is negative relationship between leverage (debt to asset ratio) and Growth (market to
book ratio).

OBJECTIVES AND AIMS

Striving to demonstrate positive relationship between debt and growth of companies by
offering the index information taken from 200 financial statements of 50 firms in HoChiMinh
Stock Exchange. And thereby hypothesis is rejected. Collecting all data for proving that if
company debt capacity increases or decreases, there is no negative effect find on the growth
of the company.

Using available data in five years to analyze two variable: Dependent variable Growth
(market to book ratio) and independent variable Leverage (debt to asset ratio). The
regression model has been formulated for these variable.

BACKGROUND AND SIGNIFICANCE

Pet and Juo (2001) found a significant negative relationship between debt by only taken bank
loan from total debt and growth by taking the minor ranges of growth while it also found a
significant positive relation in the higher range of market to book ratio. Therefore in different
growth ranges when firm has high growth range firms use more monitored debt but when
firms is in low growth range it rely on banks and financial institutes. Data taken from annual
balance sheet and income statements of capital market listed firms with excluded financial,
transportation and communication sectors.
.
Suhaila, Mat and Wan (2008) examine the determinants of the capital structure. This study
used debt ratio as dependent variable and used several others independent variables. These
are interest coverage, growth, and size and liquidity ratio. Sales is taken as a size variable and
found that it is negatively related to debt ratio. This shows that those firms who are large in
size do not depend on leverage financing or other resources while small firms depend on it.
The finding shows that larger firm in size gather equity financing easily and use retained
earnings in its capital structure. This study found negative relationship between liquidity and
debt ratio. This study used quick ratio for liquidity and found those firms that has high
liquidity ratio prefer to use a smaller amount debt.

Cai and Zhang (2006) found that firms with higher leverage changes on average have lower
returns. This study focused on earning control and firms characteristics but still they found
negative relation. This study is based on different model like pecking order and tradeoff
model but results found a negative impact on stock return. This study found a negative effect
of leverage change on future investment, suggesting that increasing leverage does lead to
future under investment. The results provide little support for the default hypothesis because
there is no evidence of healthy future investment due to leverage change and found a
significant negative effect of debt for long term period on stock returns but it also found a
weak effect of the short debt leverage on the stock.
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Heisz and Sebastien (2004) emphasize on financial structure and employment growth and
between financial structure and inventories. They worked on small firms with high leverage
and focused on inventory and employment and found that highly leverage firm also has
negative effect on employment growth and inventories. It showed that when demand of their
products decrease more than 10% employment terminated and also organization cut their
inventories more than 5% for high leverage firms compare to average and healthier firms and
specially this effect increases more in recession period (1)

Minjina (2008) found that the relationship between market to book ratio and leverage ratio is
not monotonic and is being positive for multiples with medium and low values and negative
with high values. Researcher analyzed that those companies who has low or medium market
to book ratio, have more benefits of leverage while companies with high market to book ratio
have high growth opportunities, have to maintain low leverage ratio.

Dittmar (2004) explained that usually firms having subsidiary have lower ratio of leverage
compare to their parents companies, he also showed that prior studies have worked on
negative relation between leverage and growth and has found the result but not discussed the
reason which can help companies to adjust their capital structure. When company starts its
subsidiary it starts with lower ratio of leverage and parents does not give permission to set
high debt ratio.

Kee Hoo (2006) worked on the firms opportunity of growth through research and
development together with size, leverage and industry concentration, their result show that
companies who are larger in size and their leverage increases it does not get the advantages of
R&D while firms with small in size get more advantages of growth opportunities which
means that negative impact of high leverage comes on R&D which is major source of growth
for any company. They discussed that R&D is positively related to growth opportunities
especially when firm size is large.

Peter and Gordon (2005) examine the effect of industry on firms financial decisions and
found that competitive industries financial decision is dependent on natural hedge and
medium industrys financial decision is dependent on other industry actions while
concentrated industries leverage ratio is higher, they also found that in firms the financial
5

structure, technology and risk are determined together. The results confirmed that industries
factors help to explain firm financial structure in which industry fixed factors explain less
while industry related factors explain more, they also found that in financial structure
industry changes and interdependence are more important factors which effect financial
decisions.

RESEARCH DESIGN AND METHODS

The data is taken from the financial statements in HoChiMinh Stock Exchange from 2000 to
20015. This publication provides useful information of the financial statements and stock
prices of companies has been taken from HoChiMinh Stock Exchange.
All listed firms is included and all financial firms like banks, insurance companies,
investment companies and companies who never used debt as a capital are excluded from the
data. Finally remaining 50 companies are taken in the data to examine.
The research will analysis the correlation between these two variables, and identifies the
significant relationship. Then analysing and evaluating the empirical investigation in
regression model as a statistical tool.
Market to Book Ratio (Growth) dependent variable: A ratio used to find the value of a
company by comparing the book value of a firm to its market value. It is calculated by= book
value of firm / market value of firm
Debt to asset ratio (leverage) independent variable: This is a financial ratio that shows the
part of a company's assets which is taken through debt. It is calculated by = total liabilities /
total assets

Timeframes
Duties

Time

Gather data on the independent variables and the dependent

variable in the regression model
Proceed run regression models to test the panel data research

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hypotheses.
Revisiting the rationale, hypothesis => assessing the significance
of the regression obtained results
When regression results did not clarify the issue of research, the

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writer rebuild rationale and assumptions research.

Proceed write chapter 1 + 2

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Proceed write chapter 3

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Proceed write chapter 4

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Updated data and rerun the model

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Complete Chapter 4 + 5

27/11/2015 -3/12/2015

Complete the brief presented dissertation (table of content,

references)
Submitting the 1st draft
Revised the 1st manuscript after comments from instructors
Submit the 2nd manuscript
Revised the 2nd manuscript after comments from instructors
Submit the completed version

4/12/2015

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Outline Proposals
Chapter 1: Introduction
1. Capital Structure
2. Debt Capacity
3. Firms Growth
4. Debt To Assets Ratio
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5. Market To Book Ratio

Chapter 2: Literature Review
Chapter 3: Research Methodology
1. Research Design
2. Research Objective 1: How Do Debt Capacity Effect On Tax Shield?
2.1 Data Collection
2.2 Qualitative Method
2.3 Interview Structure
3. Research Objective 2: How Can Company Change Its Debt Portion While
Maintaining Its Growth Level?
3.1 Data Collection
3.2 Dependent Variable
3.3 Independent Variable
3.4 Control Variable
3.5 Model Specification
3.6 Research Method
3.6.1

Descriptive Statistic

3.6.2

Regression Method

3.6.2.1 Fixed Effects Model

3.6.2.2 Random Effects Model
4. Testing Procedure
Chapter 4: Data Analyse and Conclusion
1. Research Objective1: How Do Debt Capacity Effect On Tax Shield?
1.1 Overview
1.2 Analyse
1.3 Conclusion
2. Research Objective 2: How Can Company Change Its Debt Portion While
Maintaining Its Growth Level?
2.1 Data Analyse
2.2 Discussion
Chapter5: Conclusion and Recommendation
1. Conclusion
2. Recommendation
Appendix
Refferences
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REFERENCES
1. Debt Ratio Analysis and Firm Investment. Nasif, Faris. 2012.
2. Capital Structure in Corporate Spin-Offs. Dittmar, Amy. 2004.
3. Size, leverage, concentration, and R&D investment in generating growth opportunities.
Yew Kee Ho; Mira Tjahjapranata; Chee Meng Yap. 2006.
4. On the Debt Capacity of. Growth Options. Michael J. Barclay, Erwan Morellec , Clifford
W. Smith Jr. 2001.
5. Debt Maturity and the Effects of Growth Opportunities and Liquidity Risk on Leverage.
Johnson, Shane A. 2003.
6. Is There an Optimal Industry Financial Structure? Peter MacKay, Gordon M. Phillips.
2002.
7. Reexamining the Relation Between Debt Mix and Growth. Xueping Wu, Piet M.F.A.
Sercu, Jun Yao. 2001.
8. Capital Structure Dynamics and Stock Returns. Cai and Zhang. 2006.
9. Corporate Financial Leverage. Andrew Heisz* andSbastien LaRochelle-Ct. 2004.