UNIVERSITY OF ECONOMICS HO CHI MINH CITY

Vietnam Netherland Programme

Master of Arts in Development Economics




Corporate Finance Replication Paper
CAPITAL STRUCTURE, EQUITY MISPRICING AND STOCK REPURCHASE
THE CASE OF VIETNAMESE FIRMS
Group 4 and Group 9




Lecturer: Dr. Vo Xuan Vinh





Ho Chi Minh City, 2014
Abstract
We use the data from consolidated financial statements of 180 listed firms in Ho Chi
Minh Stock Exchange to estimate the distance to optimal leverage and equity
mispricing which are used to independently and jointly analyze the impacts of capital
structure and mispricing on cumulative abnormal returns (CARs) and repurchase
decision. We find three main results including: (i) overvalued firms may have higher
CARs than undervalued firms; (ii) repurchase size may have positive effect on CARs
and (iii) repurchase decision is not affected by the state of leverage and equity
mispricing. The statement (i) and (iii) is different from theories and previous studies
due to some reasons: weak financial management systems, twoway relationship
betweenrepurchaseandequitymispricing,formidablerepurchasetrendoflargerfirms,
andlackofdata.

1. Introduction
Many firms are investing in repurchasing stock because of these reasons such as
signalingundervaluation,decreasetheagencycostassociatedwithexcesscash,fending
offtakeoverattemptsandmimickingindustrypeer.Repurchasingstockcanchangethe
capital structure of the firms through reducing the equity which raises the firms
leverage ratio. Inthe open market sharerepurchase,interpretingthe good news tothe
stock market and greeting with abnormal return of approximately 2% to 3% are the
mostpopularformofrepurchase.
In Vietnam market, the movement of price in stock market is fluctuated and the
common trend is going down. This reduction may cause firms capital structure and
equitymisevaluation.Therefore,theyrepurchasestock.Inthispaper,wearetoexamine
how repurchase activities, capital structure and equity mispricing affect the abnormal
returnsgainedfromrepurchaseannouncements.
On the other hand, repurchasing may help firm to adjust both their capital structure
through increasing leverage ratio and equity mispricing through increasing stock
market price. Therefore, we explore to investigate the repurchase decision based on
capitalstructureandequitymispricingmeasurements.
We use the data obtained from consolidated financial statements of 198 selected firms
listed on Ho Chi Minh Stock Exchange. The data period is fromthe end of2009 to the
endof2013.
Ourpaper has five main sections. Thefirstintroduces.Section2 presentssomerelated
theories and previous studies, section 3 describes the data and methodology, section 4
discussestheresultsandsection5concludes.

2. Literaturereview
2.1. Capitalstructuretheories
The capital structure tradeoff theoryshowsthatfirmshaveanoptimal leverageratio.
However,therearetransactioncostswhichpreventfirmsfromachievingthisdebtratio
target. These costs may be contracting and financing costs, and cost of imperfect
information. Because of transaction costs, firms actual debt ratio is usually different
fromtheiroptimalcapitalstructure.Inthesituationthatfirmsareoverlevered,theywill
decrease their debt or issue equity. By contrast, firms will repurchase their stock or
increasedebt.Hence,inthispaper,itissupposedthatfirmsalwaysattempttoachieve
theiroptimalcapitalstructure.
Intermsofthemarkettimingtheory,firmswillconsiderthetimewhentheyissuedebt
and stock in order to take advantages of good pricing opportunities (Baker and
Wurgler, 2002; Graham and Harvey, 2001; Hovakimian et al., 2001; Huang and Ritter,
2009; Leary and Roberts, 2005; Myers, 1984). We argue that the equity mispricing
impactsdrivingforcesoffirmtoachievetheirtargetdebtratio.Moreover,thecostsand
benefits of achieving target capital structure can be impacted by the discrepancy
betweenactualandoptimaldebtratio,andthelevelofequitymispricing.
2.2. Capitalstructureandsharerepurchases
Therearemanyreasonswhyfirmsrepurchaseequities.Acommonreasonisfirms
repurchasestockinordertoinformthattheirstockisundervalued(e.g.,Bravetal.,
2005;GrullonandMichaely,2004;LouisandWhite,2007;Vermaelen,1981).Moreover,
itisawaytoreduceexcesscashthatcancauseagencyproblems(Jensen,1986;Stephens
andWeisbach,1998),orfirmwanttomimictheirindustry(Massaetal.,2007).Choosing
repurchasinghelpfirmshavefinancialflexibilityinsteadofdividend(Jagannathanet
al.,2000;GuayandHarford,2000).However,thereisagapinconsideringtheimpactof
capitalstructureandequitymispricingonstockrepurchasesothispaperwillfilling
this.
Ourhypothesisisthatleverageandequitymispricinghaveimpactonfirms
repurchase.Inadditionwehypothesizethatdrivingforceofrepurchaseisincreasing
valueoffirmthroughadjustcapitalstructureandthisbenefitisinfluencedbyfirms
undervaluation.
Incomparisonbetweenthispaperandpreviousstudies,virtuallypreviousresearches
useactualdebtratioandmarkettobookratioasproxiesfortargetdebtratioand
equityvaluation.However,theseproxiesarepoorsoweattempttousebetter
measures.Inaddition,insteadofindependentlyassessingtheeffectofactualleverage
andmarkettobookratioonstockrepurchase,wetrytoinvestigateitjointly.

3. DataandMethodology
3.1. Data
We calculate variables from the consolidated financial statements of listed firms in Ho
ChiMinhStockExchange(HOSE).Wedonotincludethefinancialfirmsbecausethere
aresomedifferencesintheircapitalstructure.
Our sample involves 180 firms in five years from 2009 to 2013. We also collect stock
priceandvolumedatafromHOSE.
3.2. Measuringthedistancefromtheoptimalcapitalstructure
There are many studies about firm capital structure and they pointed out that optimal
capitalstructurecouldbedeterminedbysomefirmcharacteristicsasfollow:
LEv
I,t+1

= X
I,t
(1)
X denotes characteristics of firm; LEV is firm leverage; i and t represent for firm i in
time t. Basing on Bonaim et al. (2014), we suggest the following characteristics: EBIT
over total assets, total book liabilities and market value of equity over total assets;
depreciationovertotalassets;naturallogarithmoftotalassetsasameasureoffirmsize;
fixed assets over total assets; R&D fund over total assets and R&D dummy which
receivevalueof1whenfirmhasR&Dfund.
Almost firms prefer to reach the optimal capital structure (LEV*). Therefore, their
ownersattempttoadjustthecurrentcapitalstructureandtheiractualadjustmentmight
becorrelatedtotherealadjustmentforoptimallevel.Wecouldrepresentthisthrough:
LEv
I,t+1
- LEv
I,t
= (LEv
I,t+1

- LEv
I,t
) +
I,t+1
(2)
BecauseLEV*isunobservable,wecouldrewritethemodelfrom(1)and(2)as:
LEv
I,t+1
- LEv
I,t
= (X
I,t
- LEv
I,t
) +
I,t+1

or LEv
I,t+1
= X
I,t
+ (1 - )LEv
I,t
+
I,t+1
(3)
From model (3), we could estimate the X
I,t
part which is optimal leverage. Then we
couldcalculatethedistancefromtheoptimalcapitalstructureasfollow:
Bistance
I,t+1
= LEv
I,t+1

- LEv
I,t
(4)
In thispaper, weusetwo measurements for capital structure,theyarebook valueand
marketvalueofleveragewhicharedefinedas:
BLEv =
Long Teim Bebt + Shoit Teim Bebt
Total Assets
(S)
NLEv =
Long Teim Bebt + Shoit Teim Bebt
Long Teim Bebt + Shoit Teim Bebt + Naiket value of Equity
(6)
Market value of equity is calculated by multiplying the stock price by the amount of
commonoutstandingstocks.
WebaseonthepositiveornegativevalueofDistancetoclassifyfirmsintoUnderlevered
orOverleveredgroup.
3.3. Measuringequitymisevaluation
Thevalueoffirmsequity(V)couldbecalculatedthroughthetechniqueofdiscounting
theannualvalues.Bonaimetal.(2014)suggesttheannualvaluesasfollow:

BisthebookvalueofequityandEistheincomeoffirms.Thediscountrateisestimated
fromtheFamaFrenchthreefactormodel:
0 1 2 3
B
0
E
1
- iB
0
E
2
- iB
1
Annuityu.S(E
1
- iB
0
+ E
2
- iB
1
)
i - i
I
= (i
m
- i
I
) + SNB + BNL (7)
WeusemonthlyVietnameseGovernmentBondinterestrate,rateofreturnofVNIndex
andrateofreturnofstockpriceasproxiesfori
I
,i
m
andr.SMBandHMLarecalculated
basing on market value of equity and the ratio of book value over market value of
equity (BE/ME). SMB is the subtraction of average return of firms which has lower
market value of equity than the average level and other firms. Similarly, HML is the
subtractionofaveragereturnoffirmswhichhas30%highestand30%lowestofBE/ME
ratio.
AfterestimatingtheV,wecouldcalculatethemispricing(VP)as:
vP =
v
P
(8)
Webaseonthe30%highest,medianand30%lowestvalueofVPtoclassifyfirmsinto
OvervaluedorUndervaluedgroup.
3.4. Capitalstructure,equitymispricingandstockrepurchases
We offer two models: (a) the impact of capital structure, equity mispricing and stock
repurchasesonthecumulativeabnormalreturn(CARs,whichiscalculatedatthetime
when firms announce to repurchase stocks) and (b) the impact of capital structure,
equity mispricing on the decision of repurchasing stock. We also use some control
variables basing on Bonaim et al. (2014) including: natural logarithm of total assets;
cash flow; nonoperating cash flow; standard deviation of cash flow; cash and short
term investments; property, plant and equipment; sales growth; standard deviation of
returnsandilliquidity.

4. ResultsandDiscussion
Table4.1.Thedeterminantsoffirmleverage
BLEV MLEV
EBIT 0.1549* 0.1611
LiabilitiesandMVofEquity 0.0008 0.0268*
Depreciation 0.3604 0.4309*
Size 0.0566*** 0.0151***
FixedAssets 0.0876** 0.0403
R&D 0.0571*** 0.0889
R&DDummy 0.0378** 0.024
Leverage 0.0098 0.7693***
Constant 0.4726*** 0.0244
Rsquared 0.1967 0.7042
N 792 792
*,**and***denotesignificantlevelat10%,5%and1%respectively.
Thesignificantleveliscalculatedfromrobuststandarderror.
The Table 4.1 shows the model to for determining the distance to optimal capital
structure. There are many significant factors which affect the leverage measured by
both book value and market value. However, these factors may have a better
explanationforthemarketvalue(70.42%)ofleveragethanforbookvalue(19.67%).
Basing on the distance calculated from the model, we obtain 530 observations with
positive distance (lower than the optimal leverage) measured by book value and 630
observations with positive distance measured by market value. The total number of
observationsis1020.
Wealsoestimatetheequitymispricing.Theresultsofthediscountrate(r)fromFama
FrenchmodelandthemispricingmeasurementVPareinTable4.2below:
Table4.2.Descriptivestatisticsofdiscountrate(r)andmispricingmeasurement(VP)
N Mean Std.Dev. Min Max
Discountrate(r) 792 0.0246 0.0215 0.9241 0.7405
Mispricingmeasurement(VP) 396 317387 1122386 268746 15700636

Similar to the Distance, weusethevalueVP forclassifyingfirms intoOvervaluedand

Undervaluedgroup.ThethresholdistheVPmedian.Wealsouse30%highestand30%
lowestofVPtogenerateequitymispricingdummies.
Table4.3.DifferenceTestofCARsbetweenfirmgroupswithoutinteraction
N AverageCARs
LeveragewithBLEVApproach
Overlevered(Distance<0) 79 0.0058 Difference 0.0119
Underlevered(Distance>0) 105 0.0061 Pvalue 0.3692
LeveragewithMLEVApproach
Overlevered(Distance<0) 58 0.0108 Difference 0.0143
Underlevered(Distance>0) 126 0.0036 Pvalue 0.3108
EquityMisvaluation
Overvalued(VP>VPMedian) 106 0.0032 Difference 0.0054
Undervalued(VP<VPMedian) 78 0.0021 Pvalue 0.6872
*,**and***denotesignificantlevelat10%,5%and1%respectively.
Table4.3usestheDifferenceTestfortestingthedifferencebetweenfirmgroupswhich
is createdfrom distanceto optimalcapital structureandequity mispricing. We dothis
testamongfirmswhichhaverepurchasedstocks.Weexpecttherearedifferencesinthe
CARs between groups. We do not find any evidences about the difference in CARs
between Overlevered and Underlevered group with both book and market value.
However,wefindnoevidenceforourexpectation.
Forfurtheranalysis,weputthesegroupswithinteractionasinTable4.4below:
Table4.4.DifferenceTestofCARsbetweenfirmgroupswithinteraction
EquityMisvaluation
Overvalued
(VP>VPMedian)
Undervalued
(VP<VPMedian)
Difference
(Pvalue)
LeveragewithBLEVApproach
Overlevered(Distance<0) 0.0059 0.0057 0.0002
N=46 N=33 (0.9947)
Underlevered(Distance>0) 0.0102 0.0005 0.0097
N=60 N=45 (0.3984)
Difference 0.0161 0.0062
(Pvalue) (0.3640) (0.7565)
LeveragewithMLEVApproach
Overlevered(Distance<0) 0.0204 0.0062 0.0266
N=37 N=21 (0.1023)
Underlevered(Distance>0) 0.0060 0.0006 0.0054
N=69 N=57 (0.7645)
Difference 0.0264 0.0056
Pvalue (0.1528) (0.8036)
*,**and***denotesignificantlevelat10%,5%and1%respectively.
We still find no evidence about the difference in CARs among firm groups with
interaction. It means that there is no significant difference in CARs of firms
over/underleveredandover/undervalued.
WealsoexploreourresultsbyusingregressionmodelsasinthefollowingTable4.5:
Table4.5.ThedeterminantsofCARs
BLEV MLEV BLEV MLEV
Underlevered(1) 0.0117 0.0045 (2)&(4) 0.0227 0.0078
Overlevered(2) 0.0016 0.0111 (1)&(4) 0.0013 0.0041
Undervalued(3) 0.0294** 0.0247* (2)&(3) 0.0348 0.0450*
Overvalued(4) 0.0019 0.0004 (1)&(3) 0.0429** 0.0177
RepurchaseSize 0.0397** 0.0334* 0.0403 0.0313*
Size 0.0018 0.0029 0.0011 0.0032
CashFlow 0.1112* 0.0981* 0.0827 0.0918
NonoperatingCashFlow 0.1033* 0.0945 0.0756 0.0696
Std.DeviationofCashFlow 0.0554 0.0496 0.0356 0.0529
Cash 0.0817* 0.0640 0.0692* 0.0601
Property,Plant,Equipment 0.0237 0.0165 0.0208 0.0065
SalesGrowth 0.0001 0.0001 0.0001 0.0001
Std.DeviationofReturn 0.0158 0.0215 0.0164 0.0218
Illiquidity 0.0022 0.0020 0.0016 0.0025
Constant 0.0593 0.0970 0.0590 0.1018
Rsquared 0.1399 0.1371 0.1642 0.1249
N 134 134 134 134
*,**and***denotesignificantlevelat10%,5%and1%respectively.
Thesignificantleveliscalculatedfromrobuststandarderror.
Thebothbookvalueandmarketapproachingofleverageappearstobeindifferent.The
CARs of undervalued firms is averagely 2.94% (for BLEV) and 2.47% (MLEV) lower
than overvalued firms. Moreover, underlevered and undervalued firms have 4.29%
lowerCARsthanothersinBLEVapproaching.Inaddition,wealsofindgoodevidences
that(ii)repurchasemayhavepositiveeffectonCARs.

We omit the variable Repurchased Size and convert it into dummy to study how
leverage and equity mispricing affect the firms repurchase decision. We use logistic
regressionmethodasfollow:
Table4.6.Thedeterminantsoffirmrepurchasedecision
BLEV MLEV BLEV MLEV
Underlevered(1) 0.1981 0.0018 (2)&(4) 0.3651 0.3440
Overlevered(2) 0.0201 0.0411 (1)&(4) 0.7645** 0.4947
Undervalued(3) 0.0165 0.0146 (2)&(3) 0.0678 0.1215
Overvalued(4) 0.5335** 0.5273** (1)&(3) 0.1121 0.6362
Size 0.0042 0.0093 0.0146 0.0365
CashFlow 0.3771 0.4617 0.3566 0.5238
NonoperatingCashFlow 0.7408 0.9099 0.7592 1.0608
Std.DeviationofCashFlow 0.4164 0.3178 0.3140 0.1531
Cash 0.1313 0.3390 0.0520 0.1352
Property,Plant,Equipment 1.8817*** 1.9837*** 1.9034*** 1.9839***
SalesGrowth 0.0001 0.0001 0.0001 0.0001
Std.DeviationofReturn 1.1022*** 1.1383*** 1.0782*** 1.0683***
Illiquidity 0.1798 0.1805 0.1852 0.1970
Constant 1.2093 1.2905 1.1818 0.9231
PseudoRsquared 0.0900 0.0890 0.0917 0.0899
N 823 823 823 823
*,**and***denotesignificantlevelat10%,5%and1%respectively.
Thesignificantleveliscalculatedfromrobuststandarderror.
As can be seen the overvalued dummy coefficient is significant for both BLEV and
MLEV approaching. Therefore, overvalued firms may have high probability to
repurchasetheirstock.
Insum,wehavethreemainstatementsinourpaper:
(i) UndervaluedfirmsmayhavelowerCARsthanovervaluedfirms.
(ii) RepurchasesizemayhavepositiveeffectonCARs.
(iii) Overvaluedfirmsmayhavehighprobabilitytorepurchasetheirstock.
In difference test analysis, the results of Bonaim et al. (2014) show that underlevered
firmshavehigherCARsaroundrepurchaseannouncementthanoverleveredfirmsand
undervalued firms have higher announcement returns than overvalued firms. In
addition, the firms which are both overlevered and overvalued have lowest
announcement returns; by contrast, undervalued and underlevered firms have highest
CARs. Unlike original study, our paper shows that there are no differences in CARs
between two groups underlevered and overlevered firms, while undervalued firms
have lower announcement returns than overvalued firms. These results are also
differentfromourpredictions.
Asfarasregressionanalysisisconcerned,incontrasttooriginalstudy,almostleverage
and mispricing dummy variables and its interactions have no impact on CARs. In
addition, the negative sign of undervalued variable and positive sign of overvalued
variable are consistent with difference test analysis, but it is not similar to our
expectations. In terms of analyzing determinants of the share repurchase decision,
resultsofBonaimetal.(2014)showthatunderleveredandundervaluedaremostlikely
to repurchase stock, while our paper point out that overvalued firms may have high
probabilitytorepurchasetheirstock.
Thedifferencesofourresultsfromoriginalstudyandexpectationscanbeexplainedby
somefollowingreasons:
The role of financial management in Vietnamese firm, especially medium and
smallfirms,isnotappreciated.Hence,achievingoptimalstructuremaybenotan
importanttargetofmanyfirmsinVietnam.
Theremaybetwowayrelationshipbetweenrepurchaseandequitymispricing.
The lack of data (small sample) can cause some regression problem. Moreover,
because data of repurchase announcement, we calculate CARs basing on
implementation date. This can cause bias in CARs and coefficients of our
estimations.

5. Conclusion
This study attempts to investigate the influences of capital structure and equity
mispricing on security repurchase. The tradeoff theory shows that firms have an
optimalleverageratioandtheywanttoachieveit.Moreover,followthemarkettiming
theory, equity mispricing impacts driving forces of firms to achieve their target debt
ratio. Hence, according to theory, firms can alter leverage by repurchasing or issuing
stock,andinthecaseofundervaluation,thebenefitofrepurchasebroughttothefirms
isgreatest.
However, unlike the predictions from theory and original study, we find that
overvaluedfirmsmayhavehigherCARsthanundervaluedfirms,repurchasesizemay
have positive effect on CARs and repurchase decision is not affected by the state of
leverage and equity mispricing. These can be results of firms weak financial
managementsystemsandlackofdata.

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Members: Group4: TrnhHongVit
LHuNhtQuang
DngThinCh
PhanDuyLp
NguynTrnHong
Group9: NguynThiDng
HongDuyKhoa
PhmThThy
ThMinhNguyt
TrnQucThanh