UNIVERSITY OF ECONOMICS

HO CHI MINH CITY

VIETNAM

ERASMUS UNVERSITY ROTTERDAM

INSTITUTE OF SOCIAL STUDIES

THE NETHERLANDS

VIETNAM – THE NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE EFFECT OF CASH FLOW SENSITIVITY

ON ENTERPRISES’ CASH HOLDINGS:

EVIDENCE FROM VIETNAM

BY

LE KHA TU

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, December 2017

UNIVERSITY OF ECONOMICS

HO CHI MINH CITY

VIETNAM

INSTITUTE OF SOCIAL STUDIES

THE HAGUE

THE NETHERLANDS

VIETNAM - NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE EFFECT OF CASH FLOW SENSITIVITY

ON ENTERPRISES’ CASH HOLDINGS:

EVIDENCE FROM VIETNAM

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

LE KHA TU

Academic Supervisor:

Dr. NGO MINH HAI

HO CHI MINH CITY, December 2017

ABSTRACT

Cash holdings have long been a particular concern when studying the financial

policies of enterprises. The global financial crisis in 2008 has impacted many

economies in the world; Vietnam was one of the few emerging economies in

Southeast Asia being less affected by the crisis. However, the crisis has negative

impacts on the macroeconomy of Vietnam. Low GDP growth rates, booming inflation

and escalating interest rates made Vietnamese enterprises’ situation more difficult.

Along with the Central bank's tightening monetary policy to curb inflation,

commercial banks simultaneously restricted the issuance of large loans, which were

more difficult for firms to access more capital. In that context, the efficient use of cash

holdings is the key to business success. To use effectively the cash flow of the firms, it

is important to study the factors that affect the cash holdings of firms. Thus, the author

chose the topic "The effect of cash ﬂow sensitivity on enterprises’ cash holdings:

Evidence from Vietnam" to study the effect of financial factors on firms’ cash

holdings in Vietnam. The main objective of the study was to find empirical evidence

on the effects of cash flow sensitivities on cash holdings in the world and to seek

evidence of this in Vietnam. The study uses data from financial statements of 274

non-financial firms listed on Hanoi Stock Exchange (HNX) and Hochiminh Stock

Exchange (HOSE) between 2009 and 2015. In Vietnam, cash flow sensitivities have a

real impact on the cash holdings of firms, which is greater for firms with negative cash

flows. The financial constraint also affects the relationship between cash flow

sensitivity and cash holdings, but the agency problem does not show any significant

influence on this relationship. Based on the results of the study, the paper offers some

recommendations to help businesses make better cash management options. At the

same time, the paper also outlines some of the remaining limitations of research and

future research.

Keywords: Cash flow sensitivity, cash holdings, financial constraint, agency problem,

asymmetric

i

ACKNOWLEDGEMENT

The first word I would like to send my sincere thanks to all Vietnam – Netherlands

Programme professors, who have taught and imparted me valuable knowledge during

the time of study and research, enabling me to complete this thesis. You all not only

gave me the knowledge but also created the best conditions for me in the data

collection and thesis writing process. Friendly and kind Vietnam – Netherlands

Programme staff were always willing to help me on physical facilities as well as

references.

I would like to sincerely and gratefully thank Dr. Ngo Minh Hai, my supervisor, for

his great assistance, principal and valued advice, guiding me from the smallest steps to

help my thesis complete.

I would like to express my deep gratitude to all my friends, families, who have always

been with me, cheered and supported me all the time.

Despite all the effort, due to limited knowledge and time, the problems presented in

this thesis will certainly have many shortcomings. I look forward to receiving

feedback, evaluations and comments from the professors.

ii

CONTENTS

CHAPTER 1: INTRODUCTION ................................................................................ 1

1.1

The problem statement ...................................................................................... 1

1.2

The research objectives ..................................................................................... 2

1.3

Research contribution ....................................................................................... 2

1.4

The thesis structure ........................................................................................... 3

CHAPTER 2: LITERATURE REVIEW .................................................................... 4

2.1

Introduction ....................................................................................................... 4

2.2

Studies on the effects of cash flow sensitivity on cash holdings ...................... 4

2.2.1 The impact of change in cash flow on cash holdings ..................................... 4

2.2.2 The relationship between financial constraints and cash holdings of a

company ................................................................................................................... 7

2.3

Summary of previous findings .......................................................................... 9

CHAPTER 3: RESEARCH METHODOLOGY ...................................................... 13

3.1

The analytical framework ............................................................................... 13

3.2

The econometric models ................................................................................. 14

3.2.1 Model the effect of cash flow sensitivity on cash holdings ........................... 14

3.2.2 The effect of cash flow sensitivity on cash holdings is under financial

constraints .............................................................................................................. 15

3.2.3 The effect of cash flow sensitivity on cash holdings is in the agency problem

................................................................................................................................ 17

3.3

The data .......................................................................................................... 20

3.4

Fixed Effects and Random Effects ................................................................. 20

3.5

GMM4 estimations ......................................................................................... 21

3.6

Expectations on research results ..................................................................... 22

3.6.1 Effects of cash flow sensitivity on cash holdings .......................................... 22

3.6.2 Effects of cash flow sensitivity on cash holdings under financial constraints

................................................................................................................................ 23

3.6.3 Effects of cash flow sensitivity on cash holdings under agency problem ..... 23

CHAPTER 4: RESEARCH RESULTS ..................................................................... 24

4.1

Data description .............................................................................................. 24

iii

4.2. Regression results and discussions .................................................................... 28

4.2.1 Effects of cash flow sensitivity on cash holdings .......................................... 28

4.2.2 Effects of cash flow sensitivity on cash holdings under financial constraints

................................................................................................................................ 37

4.2.3 Effects of cash flow sensitivity on cash holdings under agency problem ..... 42

CHAPTER 5: CONCLUSIONS ................................................................................. 45

5.1

Conclusions ..................................................................................................... 45

5.2

Policy implications .......................................................................................... 46

5.3.

Limitations ...................................................................................................... 47

REFERENCE............................................................................................................... 49

APPENDIX................................................................................................................... 51

iv

LIST OF TABLES

Table 4. 1: Sample statistics ......................................................................................... 24

Table 4. 2: Variable description ................................................................................... 25

Table 4. 3: Compare the mean of variables .................................................................. 25

Table 4. 4: Pearson and Spearman correlation coefficients ......................................... 27

Table 4. 5: The results of Almeida (2004) ................................................................... 29

Table 4. 6: Estimation results of the model .................................................................. 31

Table 4. 7: Results of the asymmetry sensitivity of cash flow ..................................... 34

Table 4. 8: Cash Flow and Cash of FPT Corporation for the period 2009 – 2015 ...... 36

Table 4. 9: The number of observations of companies by year divided into three

categories ...................................................................................................................... 38

Table 4. 10: The summary statistics for the cash holdings of the two groups of

companies by the three classification criteria ............................................................... 39

Table 4. 11: Estimation results for financial constraints .............................................. 40

Table 4. 12: Estimation results of the model for agency problem ............................... 43

v

CHAPTER 1: INTRODUCTION

1.1

The problem statements

The 2008 financial crisis was the worst economic disaster since the Great Depression

of 1929, having a strong impact on the world in general and Southeast Asia in

specific. However, Vietnam was one of the few economies that were less affected by

the recession caused by this crisis. Nevertheless, the GDP growth rates for seven

consecutive years (from 2009 to 2015) were in low level, showing that the crisis still

had negative impacts on Vietnamese economy. Moreover, in the period of 2009-2015,

Vietnam’s inflation was abnormal (a sudden increase to 19% in 2011 and then

declining), bad debts became a serious problem and getting worse. Vietnamese

enterprises were directly affected by the crisis, the number of enterprises reporting

losses was increasing and many businesses were forced to dissolve. In that context,

cash holdings were paid more attention, since cash management is the key to a success

business as accessing capital markets is difficult. For effective cash management, the

first problem is what factors affect the firm's cash holdings.

Prior literature has widely studied the effects of cash flow on cash holdings and got

certain conclusions. Almeida et al. (2004), Khurana et al. (2006) found cash flow

sensitivity was positive. Meanwhile, Riddick and Whited (2009), Bao, Chan and

Zhang (2012) found that cash flow sensitivity was negative.

The study of cash flow sensitivity of cash holdings may help firms proposing a better

cash management model, thereby firms use cash more efficiently. However, in

Vietnam, the effect of cash flow sensitivity on cash holdings has yet to be studied

extensively, and there are disputations on this problem in the world. For this reason,

the author chose the research topic "The Effect of Cash Flow Sensitivity on Cash

Holdings: Evidence from Vietnam", examining whether or not the effect of cash flow

sensitivity on cash holdings in Vietnamese enterprises.

1

1.2

The research objectives

The main purpose is examing the effect of cash flow sensitivity on cash holdings, the

paper includes two basic objectives:

- Examining the effect of cash flow sensitivity on cash holdings in Vietnamese

enterprises

- Verifying the nonlinear relationship between cash flow sensitivity and cash holdings.

To accomplish two research objectives, the paper will solve the following research

problems:

- Is there any evidence in the world about the effect of cash flow sensitivity on cash

holdings?

- Which method is appropriate to test the effect of cash flow sensitivity on cash

holdings in Vietnam?

- What factors affects the cash flow sensitivity on cash holdings?

- What is the effect of cash flow sensitivity on cash holdings in case the firm has

positive cash flow and negative cash flow?

1.3

Research contribution

Research on the effect of cash flow sensitivities has a very important meaning,

especially for firms. Financially, cash flow sensitivity can represent a company's risk,

because cash flow sensitivity is the level of change in the company's cash when cash

flow changes. If a company has high cash flow sensitivity, this can affect corporate

financial policies such as dividends and capital structure. A company with high cashflow sensitivity is difficult to maintain a capital structure with high debt ratios due to

insecure liquidity and the company is hard to implement a good dividend policy when

cash always has instability. Thus, finding the impact of cash flow sensitivity can help

firms understand how cash flow affects their cash holdings, so they can provide better

cash management and better implementation of dividend payment and capital

mobilization policies. The results of the study will also contribute to the global debate

on how cash flow sensitivity affects cash holdings.

2

1.4

The thesis structure

The research is organized in the following chapters:

Chapter 1: Introduction. This chapter presents the reasons for choosing topics,

research objectives, research methods, research contribution and thesis structure.

Chapter 2: Overview of previous studies on the impact of cash flow sensitivity on cash

holdings. This chapter presents the results of the previous study on the effect of cash

flow sensitivity on cash holdings, findings, arguments and limited issues in these

studies.

Chapter 3: Research Methods. This chapter will detail the research model, variables in

the model, data as well as expectations about the research results.

Chapter 4: Research Results. This chapter presents and discusses the results of the

study on the effect of cash flow sensitivity on cash holdings of firms in Vietnam, the

results of examination with financial constraints and agency problem.

Chapter 5: Conclusions and limitations of the study. This chapter presents the

contributions of the research, the next research direction, and the limitations.

3

CHAPTER 2: LITERATURE REVIEW

2.1

Introduction

There are many reasons for the company to hold cash. The most basic reason is that

the company holds cash to pay off debts and finance its investments. When a company

is not limited to accessing a capital market, the company's cash holdings will be less.

But the mobilization of external funding is often associated with high capital

expenditure. Thus, firms always give priority to using cash held by the company itself

to avoid the burden of costs. One of the important cash-flowing channels for the

company is through cash flow from its revenues. The change in this cash flow will

cause the change in the company's cash holdings. Some researchers have focused on

this aspect when studying cash holdings.

2.2

Studies on the effects of cash flow sensitivity on cash holdings

2.2.1 The impact of change in cash flow on cash holdings

Almeida et. al. introduced a model of a firm’s liquidity demand that formalizes

Keynes’ intuition. The model hypothesizes that firms with capital constraints tend to

have cash holdings from cash inflows. Almeida et al argue that firms that were not

constrained in their access to funding would not show cash incentives, when the firm’s

cash flow changed, their cash holdings would not be affected while financially

constrained firms would be affected by changes in cash flow.

To test their hypotheses, Almeida et. al. used a database of manufacturing firms

between 1971 and 2000, and used OLS regression to estimate the model. The

hypothesis of the model predicted that a change in cash holdings would correspond to

the cash flow shock. The hypothesis also predicted that the cash holdings of

financially constrained firms would be affected by the attraction of future investment

opportunities. Therefore, Almeida et. al. use the Q variable to capture unobserved

information about the value of long-term growth options.

The OLS regression showed that for the limited-capital-access firms, when the cash

flow was positive, the firm would increase cash holdings and vice versa. Variable Q

had a positive and significant coefficient for financially constrained firms. With future

4

investment opportunities, the limited capital access firms would increase their cash

holdings.

Riddick and Whited (2009) validated cash flow sensitivity with different theories and

models from Almeida et. al. Riddick and Whited argued that in the Almeida model the

cash flow was positive because Almeida thought that an increase in cash flow did not

correspond to higher yield of fixed assets. So, when a company has a positive cash

flow, the company will not have incentive to transfer its highly liquid assets to fixed

assets, so the company will use increased cash flow to supplement its cash holdings.

The results of Riddick and Whited differed from the results of Almeida et. al. It was

caused by correction of the measurement error in the Tobin's Q variable. Greene

(1997, p. 440) argued that the measurement error in Tobin's Q variable could affect

cash flow variable because of the measurement error. In a regression variable it affects

all coefficients of variables in regression if this regression variable correlates with

other variables.

Riddick and Whited used the fourth-order GMM estimation to overcome the problem

of measurement errors in Tobin's Q. The results showed that when a company has

positive cash flow, its cash reserves would fall. This happens because when there was

a positive yield shock that increased cash flow and margin profit of capital, the

substitution effect would cause the company to use cash reserves to purchase more

productive tangible assets and use cash to invest, so their cash reserves will decrease.

Bao, Chan and Zhang (2012) also used the GMM4 estimation with additional

empirical model to confirm the results of Riddick and Whited. Bao, Chan and Zhang

added to the experimental model of Riddick and Whited several limited control

variables such as firm size, capital expenditure, non-cash flow, and short-term debt.

The results confirmed the results of Riddick and Whited that the relationship between

cash flow sensitivity and cash holdings is negatively correlated.

At the same time as testing the impact of cash flow sensitivity on cash holdings,

researchers also concern that the relationship between cash flow and cash flow

sensitivity is linear or nonlinear. The linear relationship between a change in cash flow

and cash flows suggests that regardless the cash flow change is positive or negative,

5

the magnitude of change in cash reserves is unchanged. According to Faulkender and

Wang (2006), lacking cash would diversify the company's cash reserves. This

suggests that there are grounds to believe that the impact of cash flow sensitivity on

cash flow will be different in the two cases where the firm has positive cash flow and

the company has negative cash flow.

Research results from Almeida et al. (2004) indicated that firms were limited in their

abilities to access funding, i.e. the firms that were financially constrained, had positive

cash flow sensitivity, but did not show the difference in the effect of cash-flow

sensitivity on cash flow in two cases: the firm has positive cash flow and the firm has

negative cash flow.

Riddick and Whited (2009, p. 1793) also pointed out briefly that medium and large

firms exhibit negative nonlinear relationships in cash flow sensitivity, however, the

study of Riddick and Whited did not focus on the nonlinear relationship between cash

flow and cash flow sensitivity. Riddick and Whited pointed out firms with an increase

in cash flow tended to hold cash on investments because positive cash flow was the

evidence that tangible assets were more productive. In addition, as cash flows

increased, firms used cash reserves to invest in highly profitable projects. Conversely,

when a company had negative cash flow, this indicated that the tangible fixed assets

were of low productivity, or the company had projects with negative NPV. Then the

company would immediately stop these projects to save cash. Hence, according to

Riddick and Whited, whether a company has a positive or negative cash flow, the

relationship between cash flow sensitivity and cash holdings remains negative.

Bao, Chan and Zhang (2012) argued that a company could not immediately stop the

negative NPVs projects when the company has negative cash flow for three reasons.

First, some projects were accompanied by binding contracts and the company could

not stop these projects immediately, this was common when these were tender

projects. The second reason was indicated by Kothari et. al. (2009) that managers had

an incentive to hide bad information. If a company immediately terminates a bad

project, then maybe the market will realize the problem in that company. So, some

managers may choose to keep bad projects to minimize bad news. By delaying the

6

release of bad news, managers expect to be able to extend the time until there is good

information to neutralize the impact of bad news. Therefore, when a company faces

negative cash flow, the company may not end up ineffective projects. The third was

the agency problem, Jensen and Meckling (1976), Jensen (1986) pointed out that

managers had an incentive to invest excessively and therefore they could keep some

projects with negative NPV to maximize personal profit. This is similar to the risk

transfer in case of financial exhaustion, so when the company has negative cash flow,

the cash reserves of the company may not increase but may decrease as managers

continue to bring cash to invest in projects with negative NPV.

Because of three above reasons, a company facing negative cash flow may not

immediately stop all bad projects, when the company has negative cash flow, the

company's cash reserves may not increase. Using the samples of manufacturing firms

from 1972 to 2006, Bao, Chan and Zhang examined animpact of cash flow sensitivity

on cash flows including the viability of the nonlinear relationship corresponding to a

change in cash holdings between the two cases where the firm had positive cash flow

and the firm has negative cash flow. Empirical evidence suggested that cash flow

sensitivity would be negative when the firm had positive cash flow, in line with

Riddick and Whited (2009), but the sensitivity of cash flow would be positive when

the firm had a positive cash flow, this supports the hypothesis of Bao, Chan and

Zhang that the influence of cash flow sensitivity on cash holdings is asymmetrical.

2.2.2 Relationship between financial constraints and cash holdings of a company

Two areas of important research in corporate finance are the impact of financial

constraints on corporate policy and how firms manage finance. These two areas have a

close relationship. If a company has unlimited access external funding, which means

the firm is not financially constrained, the company does not need to have cash

reserves for future investment. On the contrary, if a company is limited in accessing

external funding because of high cost, cash reserves are necessary to cover the needs

of the company.

According to Kaplan and Zingales (1997), the most accurate and most widely used

definition of financial constraints firms was that these firms distinguish the internal

7

and external capital expenditure. However, by definition, every company seems to be

financially constrained. A small transaction cost of using external funding is sufficient

to rank the company into financial constraints. Fazzari, Hubbard and Petersen (1988)

and many other researchers considered that the cash-flow sensitivity of the higher

investment was the evidence for larger financial constraints.

In their study, Almeida et. al. (2004) demonstrated that the relationship between

financial constraints and the company's payment needs could help determine whether

financial constraints were an important determinant of corporate behavior or not.

Almeida argued that holding cash was expensive, as higher cash savings would

require cuts from profitable investment projects. Therefore, financially constrained

firms choose an optimal cash policy to balance the returns of present and future

investment projects. This policy is the opposite of firms that are not financially

constrained: firms which are not financially constrained neither use cash nor face the

cost of cash holdings.

Almeida uses five methods to classify firms into two group of financially constrained

and un-constrained firms: dividend payment policy, asset size, bond ratio, percentage

of commercial papers and KZ (based on Kaplan and Zingales (1997)).

Almeida et. al. (2004) concluded that changes in cash flow affected cash holdings

only when firms were constrained in access to capital, for firms with no financial

constraints, changing cash flows would not affect cash holdings. This may be caused

by financially constrained firms tending to hold cash, because of the limited capital

access, while financially un-constrained firms do not.

Riddick and Whited (2009) predicted that firms with higher external capital

expenditure would have a greater negative correlation coefficient. The results of the

regression of Riddick and Whited did not support the opinion of Almeida et al. in

which financial constraint firms did not have cash flow sensitivities of holding cash,

and even did not support Riddick and Whited’s prediction stated above.

The research results of Bao, Chan and Zhang (2012) supported Riddick and Whited

(2009) that cash-flow sensitivity was stronger for medium- and large-sized firms

because these firms had no financial constraints.

8

2.3

Summary of previous findings

Although previous studies use different empirical models and methods, most of the

studies conclude that cash flow sensitivity has an effect on cash holdings. The

discussed problem is how this effect tends to be. Almeida et. al. (2004) used the OLS

method for data taken from US manufacturing firms in the period 1971-2000. The

positive relationship between changes in cash holding and cash flow indicates that

firms decrease (or increase) cash reserves when they have negative (or positive) cash

flows. A change of cash flow only affects cash holdings for firms with financial

constraints. Almeida et. al. found that their findings were consistent with their

argument and argued that only financially constrained firms, because of their

restricted access to external capital markets, saved cash out of cash flow, while

unconstrained firms did not. In the same direction of research with Almeida, Khurana

et al. (2006) also drew the same conclusion.

In normal intuition, the conclusion of Almeida et al. seems to be right, when a firm

has a positive cash flow i.e. profitable business operations, the firm will bring that

profit back into its cash reserves. However, some researchers disagree with Almeida's

argument. Riddick and Whited (2009) argued that the results of Almeida showed

positive cash flow sensitivity because in Almeida's model, the increase in cash flow

did not correspond to the increase in productivity of physical assets. Riddick and

Whited contended that a firm with an increase in cash flow tended to turn cash

reserves into investments because the positive cash flow shock indicated higher

productivity of physical assets. Riddick and Whited thought the positive cash flow

sensitivity was not appropriate because of the OLS method. Riddick and Whited

pointed out that due to the measuring error of Tobin's Q variable, using the OLS

method would affect the coefficient of other variables in the estimation, especially the

cash flow variable. Hence, Riddick and Whited used a general method of moment

(GMM) estimation, proposed by Erickson and Whited (2000), to estimate the model.

The results were consistent with Riddick and Whited's original hypothesis, the cash

flow sensitivity was negative, which meant that firms with an increase in cash flow

tended to turn cash reserves into investments, reducing firm's cash holdings. On the

other hand, the results of Riddick and Whited also rejected other conclusion by

9

Almeida et al.. Almeida said that firms were not financially constrained, their cash

was not affected by changes in cash flow, Riddick and Whited proved that firms

without financial constraints had cash flow sensitivity, and even the cash flow

sensitivity of these firms was greater than that of financially constrained firms.

Sharing the same empirical method with Riddick and Whited (2009), suggesting that

the fourth-order GMM (GMM4) was more suitable than OLS, Bao, Chan and Zhang

(2012) performed a reassessment of the effect of cash flow sensitivity on cash

holdings and the research results support the outcome of Riddick and Whited.

However, Bao, Chan, and Zhang went further than Riddick and Whited to pay

attention to a nonlinear relationship between cash flow sensitivity and cash holdings.

Bao, Chan and Zhang argued that cash flow sensitivity was not negative in all cases,

particularly when the firm had negative cash flow. Riddick and Whited argued that

when a firm had negative cash flow it meant the productivity of the firm's physical

assets was decreasing or the firm was investing in ineffective projects. Then the firm

would stop funding projects or stop procuring assets, which would increase the firm's

cash. Bao, Chan and Zhang in their study gave some main reasons why the firm could

not immediately stop ineffective projects, therefore, when firm had negative cash

flow, the negative cash flow sensitivity may not be sustainable. The empirical results

confirmed the predictions of Bao, Chan and Zhang.

Besides the studies on the effects of cash flow sensitivity on cash holdings, studies on

impacts of agent costs on the effect of cash flow sensitivity on cash holdings had

certain results. Dittmar, Mahrt-Smith, and Servaes (2003) argued that if firms have a

larger agency problem, firms would hold more cash. Bao, Chan and Zhang (2012)

found a link between external control and the effect of cash flow sensitivity on cash

holdings. If the firm's shares were held by institutional investors, i.e. the firm had a

large external control and a lower agency, the effect of cash flow sensitivity on cash

holdings would be smaller.

10

CHAPTER 3: RESEARCH METHODOLOGY

3.1

The analytical framework

Increasing

investment

Firm

performance

Increasing tangible

assets

Agency problem

The sensitivity

of Cash flow

Cash holdings

Cost of holding

money

Financial

constraint

Investment

opportunities

The difficulties in

accessing capital

External capital

cost

13

3.2

The econometric models

Based on research objectives, the paper has three problems to clarify. The first is the

influence of cash flow sensitivity on cash holdings, the second is the impact of

financial constraints the last is the agency cost. Therefore, the research paper uses

three models to solve the above problems.

3.2.1 Model the effect of cash flow sensitivity on cash holdings

Based on the model of Bao, Chan and Zhang (2012), the paper uses the following

model to test the hypothesis that cash flow sensitivity affects cash holdings and this

effect is different in case the firm has negative and positive cash flow:

ΔCashHoldingsit = α0 + α1CashFlowit + α2Negit + α3Cashflowit * Negit + α4Qit +

α5Sizeit + α6Expenditureit + α7Acquisitionit + α8ΔNCWCit + α9ShortDebtit-1 + εit

(1)

Where:

CashHoldings: is calculated as the cash in company divided by total asset.

ΔCashHoldings: the difference of cash between year t and year t−1 over total assets

CashFlow: is the profit after interest, dividends and taxes payments plus depreciation

over total assets.

Neg: is the indicator variable. Neg equals zero if in that year the firm has positive cash

flow and one otherwise.

Q: represents the market capitalization of the company. Q is calculated by total of the

market value of the capital and the book value of assets minus the book value of the

capital and divided by the book value of assets.

Size: represents the scope of the company, calculated as the natural logarithm of total

assets.

Expenditure: the ratio of capital expenditures to total assets.

Acquisition: the indicator variable. If the company has no acquisition in that year,

Acquisition equals one and zero otherwise.

14

NCWC: is calculated as net non-cash working capital which equals working capital

minus cash divided by total assets.

ΔNCWC: is the difference of NCWC between year t and year t−1.

ShortDebt: is the debt in short-term weighted by total assets.

i and t refers to firm and year respectively, ε is random error term.

3.2.2 The effect of cash flow sensitivity on cash holdings is under financial constraints

After examining the effect of cash flow sensitivity on cash holdings, the study

examines how cash flow sensitivity varies between financially constrained and unconstrained firms. For that purpose, the paper uses three measures to divide the

sample into two groups.

Firstly, the paper uses the KZ index, which is based on the results of Kaplan and

Zingales (1997). The study uses the KZ index as the data for this metric corresponds

to the data in Vietnam. The KZ index is calculated as follows:

KZindex = -1.002 x CashFlow + 0.283 x Q + 3.139 x Leverage - 39.368 x Dividends 1.315 x CashHoldings

Where:

CashFlow: is the profit after interest, dividends and taxes payments plus depreciation

over total assets.

Q: represents the market capitalization of the company. Q is calculated by total of the

market value of the capital and the book value of assets minus the book value of the

capital and divided by the book value of assets.

Leverage: represents the capital structure of the firm which is calculated as the ratio of

the total debt and total assets.

Dividends: represents the dividend policy of the company which is calculated as the

cash dividends divided by total assets.

CashHoldings: is calculated as the cash in company divided by total asset.

15

The study evaluates firms via the KZ index based on Almeida et al. (2004), within a

year, firms ranked among the 33% of the highest KZ index are considered as in the

financial constraint group.

Secondly, the study uses an additional index to assess the financial constraints among

firms. This index is based on the research by Whited and Wu (2006) and is called the

WW index. Bao, Chan, and Zhang (2012) argued that the WW was more appropriate

than the KZ as firm’s characteristics in the WW were more related to the firm's

financial constraints than the KZ. The WW is more relevant than the KZ since the

WW does not include Tobin's Q. The data for calculating the WW are also consistent

with the data in Vietnam. The WW index is calculated as follows:

WWindex = -0.091 x CashFlowit - 0.062 x DIVPOSit + 0.021 x TLTDit – 0.044 x Sizeit

+ 0.102ISGit – 0.035 x SGit

Where:

CashFlow: is the profit after interest, dividends and taxes payments plus depreciation

over total assets.

DIVPOS: the indicator variable. If firm i pays dividend by cash in year t, DIVPOS is

consider as one and zero otherwise.

TLTD: is the debt in long-term weighted by total assets.

Size: represents the scope of the company, calculated as the natural logarithm of total

assets.

ISG: the industry's revenue growth rate.

SG: the growth rate of the company.

According to Bao, Chan and Zhang (2012), in a year, firms in the top 25% of the

highest WW index were considered as firms in the financial constraint group.

Finally, the study assesses whether firm is assigned to the financially constrained

group or not based on dividend payments. If a firm does not pay dividends during the

year, then the firm is considered ﬁnancially constrained ﬁrms and vice versa.

16

After dividing the sample into two groups, the equation (1) is adjusted to examine the

effect of financial constraints on the firm's cash holdings. The study is modified

equation (1) into equation (2) as follows:

ΔCashHoldingsit = β0 + β1CashFlowit + β2Negit + β3Cashflowit * Negit +

β4Constraintit + β5CashFlowit * Constraintit + β6Constraintit * Negit + β7CashFlowit *

Constraintit * Negit + β8Qit + β9Sizeit + β10Expenditureit + β11Acquisitionit +

β12ΔNCWCit + β13ShortDebtit-1 + εit

(2)

The variables in equation (2) are defined as in equation (1)

In equation (2), there is a constraint dummy variable (value of one if the firm is

considered financially constrained) and Constraint's interactive variables with

CashFlow variable, Neg dummy variable.

3.2.3 The effect of cash flow sensitivity on cash holdings is in the agency problem

To consider the impact of the agency problem, the study uses the following model:

ΔCashHoldingsit = γ0 + γ1CashFlowit + γ2Negit + γ3Cashflowit * Negit + γ4Instit +

γ5CashFlowit * Instit + γ6Instit * Negit + γ7CashFlowit * Instit * Negit + γ8Qit + γ9Sizeit

+ γ10Expenditureit + γ11Acquisitionit + γ12ΔNCWCit + γ13ShortDebtit-1 + εit

(3)

Where: Inst equals one if the number of shares held by institutional shareholders is in

the top 10% of the company.

The variables in the model are calculated as follows:

Cash holdings, in the study of Almeida et al. (2004) on cash flow sensitivity, Almeida

et al. defined the firm's cash holdings including cash and marketable securities divided

by total assets. Bao, Chan and Zhang (2012) defined cash as the firm’s total cash

holdings divided by total assets. With data taken from Vietnameses firm’s financial

statements, the study calculates cash holdings as cash and cash equivalents on the

balance sheet, i.e. the largest liquid asset item, divided by the total assets of the firm.

𝐶𝑎𝑠ℎ𝐻𝑜𝑙𝑑𝑖𝑛𝑔 =

𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝑐𝑎𝑠ℎ 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

17

CashHoldings: is calculated as the cash in company divided by total asset.

Cash flow, Almeida et al. (2004), Bao, Chan and Zhang (2012) defined the firm’s cash

flow as earnings before extraordinary items and depreciation divided by total assets. .

Extraordinary items or expenses are stated in the income statement. However, with

data collected in Vietnam, there are no extraordinary items in the firms' income

statement. Therefore, the study takes the variable definition according to Bates et al.

(2009), in which CashFlow variable is the profit after interest, dividends and taxes

payments plus depreciation. By this definition, the CashFlow variable is calculated as

follows:

𝐶𝑎𝑠ℎ𝐹𝑙𝑜𝑤 =

𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑝𝑙𝑢𝑠 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Where: depreciation is taken from the depreciation of fixed assets on the indirect cash

flow statement.

Price to book value, known as the margin value q, was developed by Tobin (1969). In

this study, Tobin defined the margin value q as the ratio between the market value and

the replacement value of the asset. However, since the margin value q can not be

observed, the study uses the value of Tobin's Q to replace the margin value Q, which

is used in many empirical studies in the world such as Bates et al. (2009), Bao, Chan

and Zhang (2012). The value of Tobin's Q is calculated by comparing the firm’s

market capilization value with the respective book value.

𝑄=

𝑀𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 + 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠

Book value of debts is taken from liabilities item on balance sheet.

Market capilization equals P/B multiplied by book value of the capital ie equals

outstanding shares multiplied by price at that time.

Total book value of assets is taken from total assets item on balance sheet.

18

Capital expenditure, Riddick and Whited (2009) argued that as firm's cash flow

increased, it corresponds to an increase in the productivity of firm's tangible fixed

assets. Firms do not accumulate cash, they return cash to invest. It means firms use

cash to purchase more fixed assets when they have positive cash flow. The amount of

money a firm spending on procuring fixed assets for investment projects is called

capital expenditure, which suggests that capital expenditures may represent

investment opportunities. Based on this argument, the study calculates capital

expenditures as the difference between the firm's fixed assets in year t and t -1 plus the

fixed asset depreciation in year t and t - 1.

𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 =

𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑓𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 + 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Non-cash working capital, based on the definition of Bao, Chan and Zhang (2012),

non-cash working capital is calculated as working capital minus cash divided by total

assets. Working capital equals short-term assets minus short-term debts. Cash

holdings equal cash and cash equivalents.

𝑁𝐶𝑊𝐶 =

𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑠 − Cash and cash equivalents

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

ΔNCWC: is the difference of NCWC between year t and year t−1.

Short-term liabilities, according to Bao, Chan and Zhang (2012), ShortDebt variable is

calculated by taking short-term debts in year t-1 divided by total assets in year t.

𝑆ℎ𝑜𝑟𝑡𝐷𝑒𝑏𝑡 =

𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑠 𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑦𝑒𝑎𝑟

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Size, Bates et al. (2009) argued that there was economic benefit to the size of cash

holdings. In this study, Bates defined firm size as the natural logarithm of the firm's

total assets. This definition is also used in many other studies, such as Almeida et al.

(2004), Bao, Chan and Zhang (2012).

𝑆𝑖𝑧𝑒 = ln(𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠)

19

3.3

The data

Based on previous studies on cash holdings, the study selected data including 274

firms from the Hanoi Stock Exchange (HNX) and Hochiminh Stock Exchange

(HOSE). Selected firms are non-financial. The study excludes firms in the financial

sector, such as the real estate, securities and banking, insurance due to special

accounting standards, according to Shadi Farshadfar and Reza Monem (2013).

Sampling period is from 2009 to 2015. The data is presented panel data with 1918

observations. Data is collected from the financial statements of the firms which are

taken from Vietstock, CafeF.

3.4

Fixed Effects and Random Effects

The study uses the OLS regression method for the data panel as Fixed effects and

Random effects. The study ran two quantitative methods simultaneously with the

collected data. After running the regression, the study will use the Hausman test to

examine the results from the two methods to find the better results.

Hausman's test examines the results between the two regression models Fixed effects

and Random effects by examining the difference in the regression coefficient and the

null hypothesis assuming that the difference is not systematic. That is, if accepting the

hypothesis H0, the random effects are better. In contrast, rejecting the null hypothesis,

the Fixed effects are better.

If the Hausman test‘results indicated that FEM is better REM, the study will use the

results of the FE model. However, to eliminate the heteroskedasticity, the study will

use Robust and Cluster for the FE model.

Robust, when there is the heteroskedasticity, OLS estimation is still an unbiased

estimator. However, estimates are no longer effective because the variance is no

longer the smallest. Furthermore, the variance estimates will be biased, so that

significance level and confidence interval tests based on t and F are no longer reliable.

Derived from the idea that the OLS estimation when there is the heteroskedasticity,

the regression coefficient is correct, only the standard error is deviated, with the

20

HO CHI MINH CITY

VIETNAM

ERASMUS UNVERSITY ROTTERDAM

INSTITUTE OF SOCIAL STUDIES

THE NETHERLANDS

VIETNAM – THE NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE EFFECT OF CASH FLOW SENSITIVITY

ON ENTERPRISES’ CASH HOLDINGS:

EVIDENCE FROM VIETNAM

BY

LE KHA TU

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

HO CHI MINH CITY, December 2017

UNIVERSITY OF ECONOMICS

HO CHI MINH CITY

VIETNAM

INSTITUTE OF SOCIAL STUDIES

THE HAGUE

THE NETHERLANDS

VIETNAM - NETHERLANDS

PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS

THE EFFECT OF CASH FLOW SENSITIVITY

ON ENTERPRISES’ CASH HOLDINGS:

EVIDENCE FROM VIETNAM

A thesis submitted in partial fulfilment of the requirements for the degree of

MASTER OF ARTS IN DEVELOPMENT ECONOMICS

By

LE KHA TU

Academic Supervisor:

Dr. NGO MINH HAI

HO CHI MINH CITY, December 2017

ABSTRACT

Cash holdings have long been a particular concern when studying the financial

policies of enterprises. The global financial crisis in 2008 has impacted many

economies in the world; Vietnam was one of the few emerging economies in

Southeast Asia being less affected by the crisis. However, the crisis has negative

impacts on the macroeconomy of Vietnam. Low GDP growth rates, booming inflation

and escalating interest rates made Vietnamese enterprises’ situation more difficult.

Along with the Central bank's tightening monetary policy to curb inflation,

commercial banks simultaneously restricted the issuance of large loans, which were

more difficult for firms to access more capital. In that context, the efficient use of cash

holdings is the key to business success. To use effectively the cash flow of the firms, it

is important to study the factors that affect the cash holdings of firms. Thus, the author

chose the topic "The effect of cash ﬂow sensitivity on enterprises’ cash holdings:

Evidence from Vietnam" to study the effect of financial factors on firms’ cash

holdings in Vietnam. The main objective of the study was to find empirical evidence

on the effects of cash flow sensitivities on cash holdings in the world and to seek

evidence of this in Vietnam. The study uses data from financial statements of 274

non-financial firms listed on Hanoi Stock Exchange (HNX) and Hochiminh Stock

Exchange (HOSE) between 2009 and 2015. In Vietnam, cash flow sensitivities have a

real impact on the cash holdings of firms, which is greater for firms with negative cash

flows. The financial constraint also affects the relationship between cash flow

sensitivity and cash holdings, but the agency problem does not show any significant

influence on this relationship. Based on the results of the study, the paper offers some

recommendations to help businesses make better cash management options. At the

same time, the paper also outlines some of the remaining limitations of research and

future research.

Keywords: Cash flow sensitivity, cash holdings, financial constraint, agency problem,

asymmetric

i

ACKNOWLEDGEMENT

The first word I would like to send my sincere thanks to all Vietnam – Netherlands

Programme professors, who have taught and imparted me valuable knowledge during

the time of study and research, enabling me to complete this thesis. You all not only

gave me the knowledge but also created the best conditions for me in the data

collection and thesis writing process. Friendly and kind Vietnam – Netherlands

Programme staff were always willing to help me on physical facilities as well as

references.

I would like to sincerely and gratefully thank Dr. Ngo Minh Hai, my supervisor, for

his great assistance, principal and valued advice, guiding me from the smallest steps to

help my thesis complete.

I would like to express my deep gratitude to all my friends, families, who have always

been with me, cheered and supported me all the time.

Despite all the effort, due to limited knowledge and time, the problems presented in

this thesis will certainly have many shortcomings. I look forward to receiving

feedback, evaluations and comments from the professors.

ii

CONTENTS

CHAPTER 1: INTRODUCTION ................................................................................ 1

1.1

The problem statement ...................................................................................... 1

1.2

The research objectives ..................................................................................... 2

1.3

Research contribution ....................................................................................... 2

1.4

The thesis structure ........................................................................................... 3

CHAPTER 2: LITERATURE REVIEW .................................................................... 4

2.1

Introduction ....................................................................................................... 4

2.2

Studies on the effects of cash flow sensitivity on cash holdings ...................... 4

2.2.1 The impact of change in cash flow on cash holdings ..................................... 4

2.2.2 The relationship between financial constraints and cash holdings of a

company ................................................................................................................... 7

2.3

Summary of previous findings .......................................................................... 9

CHAPTER 3: RESEARCH METHODOLOGY ...................................................... 13

3.1

The analytical framework ............................................................................... 13

3.2

The econometric models ................................................................................. 14

3.2.1 Model the effect of cash flow sensitivity on cash holdings ........................... 14

3.2.2 The effect of cash flow sensitivity on cash holdings is under financial

constraints .............................................................................................................. 15

3.2.3 The effect of cash flow sensitivity on cash holdings is in the agency problem

................................................................................................................................ 17

3.3

The data .......................................................................................................... 20

3.4

Fixed Effects and Random Effects ................................................................. 20

3.5

GMM4 estimations ......................................................................................... 21

3.6

Expectations on research results ..................................................................... 22

3.6.1 Effects of cash flow sensitivity on cash holdings .......................................... 22

3.6.2 Effects of cash flow sensitivity on cash holdings under financial constraints

................................................................................................................................ 23

3.6.3 Effects of cash flow sensitivity on cash holdings under agency problem ..... 23

CHAPTER 4: RESEARCH RESULTS ..................................................................... 24

4.1

Data description .............................................................................................. 24

iii

4.2. Regression results and discussions .................................................................... 28

4.2.1 Effects of cash flow sensitivity on cash holdings .......................................... 28

4.2.2 Effects of cash flow sensitivity on cash holdings under financial constraints

................................................................................................................................ 37

4.2.3 Effects of cash flow sensitivity on cash holdings under agency problem ..... 42

CHAPTER 5: CONCLUSIONS ................................................................................. 45

5.1

Conclusions ..................................................................................................... 45

5.2

Policy implications .......................................................................................... 46

5.3.

Limitations ...................................................................................................... 47

REFERENCE............................................................................................................... 49

APPENDIX................................................................................................................... 51

iv

LIST OF TABLES

Table 4. 1: Sample statistics ......................................................................................... 24

Table 4. 2: Variable description ................................................................................... 25

Table 4. 3: Compare the mean of variables .................................................................. 25

Table 4. 4: Pearson and Spearman correlation coefficients ......................................... 27

Table 4. 5: The results of Almeida (2004) ................................................................... 29

Table 4. 6: Estimation results of the model .................................................................. 31

Table 4. 7: Results of the asymmetry sensitivity of cash flow ..................................... 34

Table 4. 8: Cash Flow and Cash of FPT Corporation for the period 2009 – 2015 ...... 36

Table 4. 9: The number of observations of companies by year divided into three

categories ...................................................................................................................... 38

Table 4. 10: The summary statistics for the cash holdings of the two groups of

companies by the three classification criteria ............................................................... 39

Table 4. 11: Estimation results for financial constraints .............................................. 40

Table 4. 12: Estimation results of the model for agency problem ............................... 43

v

CHAPTER 1: INTRODUCTION

1.1

The problem statements

The 2008 financial crisis was the worst economic disaster since the Great Depression

of 1929, having a strong impact on the world in general and Southeast Asia in

specific. However, Vietnam was one of the few economies that were less affected by

the recession caused by this crisis. Nevertheless, the GDP growth rates for seven

consecutive years (from 2009 to 2015) were in low level, showing that the crisis still

had negative impacts on Vietnamese economy. Moreover, in the period of 2009-2015,

Vietnam’s inflation was abnormal (a sudden increase to 19% in 2011 and then

declining), bad debts became a serious problem and getting worse. Vietnamese

enterprises were directly affected by the crisis, the number of enterprises reporting

losses was increasing and many businesses were forced to dissolve. In that context,

cash holdings were paid more attention, since cash management is the key to a success

business as accessing capital markets is difficult. For effective cash management, the

first problem is what factors affect the firm's cash holdings.

Prior literature has widely studied the effects of cash flow on cash holdings and got

certain conclusions. Almeida et al. (2004), Khurana et al. (2006) found cash flow

sensitivity was positive. Meanwhile, Riddick and Whited (2009), Bao, Chan and

Zhang (2012) found that cash flow sensitivity was negative.

The study of cash flow sensitivity of cash holdings may help firms proposing a better

cash management model, thereby firms use cash more efficiently. However, in

Vietnam, the effect of cash flow sensitivity on cash holdings has yet to be studied

extensively, and there are disputations on this problem in the world. For this reason,

the author chose the research topic "The Effect of Cash Flow Sensitivity on Cash

Holdings: Evidence from Vietnam", examining whether or not the effect of cash flow

sensitivity on cash holdings in Vietnamese enterprises.

1

1.2

The research objectives

The main purpose is examing the effect of cash flow sensitivity on cash holdings, the

paper includes two basic objectives:

- Examining the effect of cash flow sensitivity on cash holdings in Vietnamese

enterprises

- Verifying the nonlinear relationship between cash flow sensitivity and cash holdings.

To accomplish two research objectives, the paper will solve the following research

problems:

- Is there any evidence in the world about the effect of cash flow sensitivity on cash

holdings?

- Which method is appropriate to test the effect of cash flow sensitivity on cash

holdings in Vietnam?

- What factors affects the cash flow sensitivity on cash holdings?

- What is the effect of cash flow sensitivity on cash holdings in case the firm has

positive cash flow and negative cash flow?

1.3

Research contribution

Research on the effect of cash flow sensitivities has a very important meaning,

especially for firms. Financially, cash flow sensitivity can represent a company's risk,

because cash flow sensitivity is the level of change in the company's cash when cash

flow changes. If a company has high cash flow sensitivity, this can affect corporate

financial policies such as dividends and capital structure. A company with high cashflow sensitivity is difficult to maintain a capital structure with high debt ratios due to

insecure liquidity and the company is hard to implement a good dividend policy when

cash always has instability. Thus, finding the impact of cash flow sensitivity can help

firms understand how cash flow affects their cash holdings, so they can provide better

cash management and better implementation of dividend payment and capital

mobilization policies. The results of the study will also contribute to the global debate

on how cash flow sensitivity affects cash holdings.

2

1.4

The thesis structure

The research is organized in the following chapters:

Chapter 1: Introduction. This chapter presents the reasons for choosing topics,

research objectives, research methods, research contribution and thesis structure.

Chapter 2: Overview of previous studies on the impact of cash flow sensitivity on cash

holdings. This chapter presents the results of the previous study on the effect of cash

flow sensitivity on cash holdings, findings, arguments and limited issues in these

studies.

Chapter 3: Research Methods. This chapter will detail the research model, variables in

the model, data as well as expectations about the research results.

Chapter 4: Research Results. This chapter presents and discusses the results of the

study on the effect of cash flow sensitivity on cash holdings of firms in Vietnam, the

results of examination with financial constraints and agency problem.

Chapter 5: Conclusions and limitations of the study. This chapter presents the

contributions of the research, the next research direction, and the limitations.

3

CHAPTER 2: LITERATURE REVIEW

2.1

Introduction

There are many reasons for the company to hold cash. The most basic reason is that

the company holds cash to pay off debts and finance its investments. When a company

is not limited to accessing a capital market, the company's cash holdings will be less.

But the mobilization of external funding is often associated with high capital

expenditure. Thus, firms always give priority to using cash held by the company itself

to avoid the burden of costs. One of the important cash-flowing channels for the

company is through cash flow from its revenues. The change in this cash flow will

cause the change in the company's cash holdings. Some researchers have focused on

this aspect when studying cash holdings.

2.2

Studies on the effects of cash flow sensitivity on cash holdings

2.2.1 The impact of change in cash flow on cash holdings

Almeida et. al. introduced a model of a firm’s liquidity demand that formalizes

Keynes’ intuition. The model hypothesizes that firms with capital constraints tend to

have cash holdings from cash inflows. Almeida et al argue that firms that were not

constrained in their access to funding would not show cash incentives, when the firm’s

cash flow changed, their cash holdings would not be affected while financially

constrained firms would be affected by changes in cash flow.

To test their hypotheses, Almeida et. al. used a database of manufacturing firms

between 1971 and 2000, and used OLS regression to estimate the model. The

hypothesis of the model predicted that a change in cash holdings would correspond to

the cash flow shock. The hypothesis also predicted that the cash holdings of

financially constrained firms would be affected by the attraction of future investment

opportunities. Therefore, Almeida et. al. use the Q variable to capture unobserved

information about the value of long-term growth options.

The OLS regression showed that for the limited-capital-access firms, when the cash

flow was positive, the firm would increase cash holdings and vice versa. Variable Q

had a positive and significant coefficient for financially constrained firms. With future

4

investment opportunities, the limited capital access firms would increase their cash

holdings.

Riddick and Whited (2009) validated cash flow sensitivity with different theories and

models from Almeida et. al. Riddick and Whited argued that in the Almeida model the

cash flow was positive because Almeida thought that an increase in cash flow did not

correspond to higher yield of fixed assets. So, when a company has a positive cash

flow, the company will not have incentive to transfer its highly liquid assets to fixed

assets, so the company will use increased cash flow to supplement its cash holdings.

The results of Riddick and Whited differed from the results of Almeida et. al. It was

caused by correction of the measurement error in the Tobin's Q variable. Greene

(1997, p. 440) argued that the measurement error in Tobin's Q variable could affect

cash flow variable because of the measurement error. In a regression variable it affects

all coefficients of variables in regression if this regression variable correlates with

other variables.

Riddick and Whited used the fourth-order GMM estimation to overcome the problem

of measurement errors in Tobin's Q. The results showed that when a company has

positive cash flow, its cash reserves would fall. This happens because when there was

a positive yield shock that increased cash flow and margin profit of capital, the

substitution effect would cause the company to use cash reserves to purchase more

productive tangible assets and use cash to invest, so their cash reserves will decrease.

Bao, Chan and Zhang (2012) also used the GMM4 estimation with additional

empirical model to confirm the results of Riddick and Whited. Bao, Chan and Zhang

added to the experimental model of Riddick and Whited several limited control

variables such as firm size, capital expenditure, non-cash flow, and short-term debt.

The results confirmed the results of Riddick and Whited that the relationship between

cash flow sensitivity and cash holdings is negatively correlated.

At the same time as testing the impact of cash flow sensitivity on cash holdings,

researchers also concern that the relationship between cash flow and cash flow

sensitivity is linear or nonlinear. The linear relationship between a change in cash flow

and cash flows suggests that regardless the cash flow change is positive or negative,

5

the magnitude of change in cash reserves is unchanged. According to Faulkender and

Wang (2006), lacking cash would diversify the company's cash reserves. This

suggests that there are grounds to believe that the impact of cash flow sensitivity on

cash flow will be different in the two cases where the firm has positive cash flow and

the company has negative cash flow.

Research results from Almeida et al. (2004) indicated that firms were limited in their

abilities to access funding, i.e. the firms that were financially constrained, had positive

cash flow sensitivity, but did not show the difference in the effect of cash-flow

sensitivity on cash flow in two cases: the firm has positive cash flow and the firm has

negative cash flow.

Riddick and Whited (2009, p. 1793) also pointed out briefly that medium and large

firms exhibit negative nonlinear relationships in cash flow sensitivity, however, the

study of Riddick and Whited did not focus on the nonlinear relationship between cash

flow and cash flow sensitivity. Riddick and Whited pointed out firms with an increase

in cash flow tended to hold cash on investments because positive cash flow was the

evidence that tangible assets were more productive. In addition, as cash flows

increased, firms used cash reserves to invest in highly profitable projects. Conversely,

when a company had negative cash flow, this indicated that the tangible fixed assets

were of low productivity, or the company had projects with negative NPV. Then the

company would immediately stop these projects to save cash. Hence, according to

Riddick and Whited, whether a company has a positive or negative cash flow, the

relationship between cash flow sensitivity and cash holdings remains negative.

Bao, Chan and Zhang (2012) argued that a company could not immediately stop the

negative NPVs projects when the company has negative cash flow for three reasons.

First, some projects were accompanied by binding contracts and the company could

not stop these projects immediately, this was common when these were tender

projects. The second reason was indicated by Kothari et. al. (2009) that managers had

an incentive to hide bad information. If a company immediately terminates a bad

project, then maybe the market will realize the problem in that company. So, some

managers may choose to keep bad projects to minimize bad news. By delaying the

6

release of bad news, managers expect to be able to extend the time until there is good

information to neutralize the impact of bad news. Therefore, when a company faces

negative cash flow, the company may not end up ineffective projects. The third was

the agency problem, Jensen and Meckling (1976), Jensen (1986) pointed out that

managers had an incentive to invest excessively and therefore they could keep some

projects with negative NPV to maximize personal profit. This is similar to the risk

transfer in case of financial exhaustion, so when the company has negative cash flow,

the cash reserves of the company may not increase but may decrease as managers

continue to bring cash to invest in projects with negative NPV.

Because of three above reasons, a company facing negative cash flow may not

immediately stop all bad projects, when the company has negative cash flow, the

company's cash reserves may not increase. Using the samples of manufacturing firms

from 1972 to 2006, Bao, Chan and Zhang examined animpact of cash flow sensitivity

on cash flows including the viability of the nonlinear relationship corresponding to a

change in cash holdings between the two cases where the firm had positive cash flow

and the firm has negative cash flow. Empirical evidence suggested that cash flow

sensitivity would be negative when the firm had positive cash flow, in line with

Riddick and Whited (2009), but the sensitivity of cash flow would be positive when

the firm had a positive cash flow, this supports the hypothesis of Bao, Chan and

Zhang that the influence of cash flow sensitivity on cash holdings is asymmetrical.

2.2.2 Relationship between financial constraints and cash holdings of a company

Two areas of important research in corporate finance are the impact of financial

constraints on corporate policy and how firms manage finance. These two areas have a

close relationship. If a company has unlimited access external funding, which means

the firm is not financially constrained, the company does not need to have cash

reserves for future investment. On the contrary, if a company is limited in accessing

external funding because of high cost, cash reserves are necessary to cover the needs

of the company.

According to Kaplan and Zingales (1997), the most accurate and most widely used

definition of financial constraints firms was that these firms distinguish the internal

7

and external capital expenditure. However, by definition, every company seems to be

financially constrained. A small transaction cost of using external funding is sufficient

to rank the company into financial constraints. Fazzari, Hubbard and Petersen (1988)

and many other researchers considered that the cash-flow sensitivity of the higher

investment was the evidence for larger financial constraints.

In their study, Almeida et. al. (2004) demonstrated that the relationship between

financial constraints and the company's payment needs could help determine whether

financial constraints were an important determinant of corporate behavior or not.

Almeida argued that holding cash was expensive, as higher cash savings would

require cuts from profitable investment projects. Therefore, financially constrained

firms choose an optimal cash policy to balance the returns of present and future

investment projects. This policy is the opposite of firms that are not financially

constrained: firms which are not financially constrained neither use cash nor face the

cost of cash holdings.

Almeida uses five methods to classify firms into two group of financially constrained

and un-constrained firms: dividend payment policy, asset size, bond ratio, percentage

of commercial papers and KZ (based on Kaplan and Zingales (1997)).

Almeida et. al. (2004) concluded that changes in cash flow affected cash holdings

only when firms were constrained in access to capital, for firms with no financial

constraints, changing cash flows would not affect cash holdings. This may be caused

by financially constrained firms tending to hold cash, because of the limited capital

access, while financially un-constrained firms do not.

Riddick and Whited (2009) predicted that firms with higher external capital

expenditure would have a greater negative correlation coefficient. The results of the

regression of Riddick and Whited did not support the opinion of Almeida et al. in

which financial constraint firms did not have cash flow sensitivities of holding cash,

and even did not support Riddick and Whited’s prediction stated above.

The research results of Bao, Chan and Zhang (2012) supported Riddick and Whited

(2009) that cash-flow sensitivity was stronger for medium- and large-sized firms

because these firms had no financial constraints.

8

2.3

Summary of previous findings

Although previous studies use different empirical models and methods, most of the

studies conclude that cash flow sensitivity has an effect on cash holdings. The

discussed problem is how this effect tends to be. Almeida et. al. (2004) used the OLS

method for data taken from US manufacturing firms in the period 1971-2000. The

positive relationship between changes in cash holding and cash flow indicates that

firms decrease (or increase) cash reserves when they have negative (or positive) cash

flows. A change of cash flow only affects cash holdings for firms with financial

constraints. Almeida et. al. found that their findings were consistent with their

argument and argued that only financially constrained firms, because of their

restricted access to external capital markets, saved cash out of cash flow, while

unconstrained firms did not. In the same direction of research with Almeida, Khurana

et al. (2006) also drew the same conclusion.

In normal intuition, the conclusion of Almeida et al. seems to be right, when a firm

has a positive cash flow i.e. profitable business operations, the firm will bring that

profit back into its cash reserves. However, some researchers disagree with Almeida's

argument. Riddick and Whited (2009) argued that the results of Almeida showed

positive cash flow sensitivity because in Almeida's model, the increase in cash flow

did not correspond to the increase in productivity of physical assets. Riddick and

Whited contended that a firm with an increase in cash flow tended to turn cash

reserves into investments because the positive cash flow shock indicated higher

productivity of physical assets. Riddick and Whited thought the positive cash flow

sensitivity was not appropriate because of the OLS method. Riddick and Whited

pointed out that due to the measuring error of Tobin's Q variable, using the OLS

method would affect the coefficient of other variables in the estimation, especially the

cash flow variable. Hence, Riddick and Whited used a general method of moment

(GMM) estimation, proposed by Erickson and Whited (2000), to estimate the model.

The results were consistent with Riddick and Whited's original hypothesis, the cash

flow sensitivity was negative, which meant that firms with an increase in cash flow

tended to turn cash reserves into investments, reducing firm's cash holdings. On the

other hand, the results of Riddick and Whited also rejected other conclusion by

9

Almeida et al.. Almeida said that firms were not financially constrained, their cash

was not affected by changes in cash flow, Riddick and Whited proved that firms

without financial constraints had cash flow sensitivity, and even the cash flow

sensitivity of these firms was greater than that of financially constrained firms.

Sharing the same empirical method with Riddick and Whited (2009), suggesting that

the fourth-order GMM (GMM4) was more suitable than OLS, Bao, Chan and Zhang

(2012) performed a reassessment of the effect of cash flow sensitivity on cash

holdings and the research results support the outcome of Riddick and Whited.

However, Bao, Chan, and Zhang went further than Riddick and Whited to pay

attention to a nonlinear relationship between cash flow sensitivity and cash holdings.

Bao, Chan and Zhang argued that cash flow sensitivity was not negative in all cases,

particularly when the firm had negative cash flow. Riddick and Whited argued that

when a firm had negative cash flow it meant the productivity of the firm's physical

assets was decreasing or the firm was investing in ineffective projects. Then the firm

would stop funding projects or stop procuring assets, which would increase the firm's

cash. Bao, Chan and Zhang in their study gave some main reasons why the firm could

not immediately stop ineffective projects, therefore, when firm had negative cash

flow, the negative cash flow sensitivity may not be sustainable. The empirical results

confirmed the predictions of Bao, Chan and Zhang.

Besides the studies on the effects of cash flow sensitivity on cash holdings, studies on

impacts of agent costs on the effect of cash flow sensitivity on cash holdings had

certain results. Dittmar, Mahrt-Smith, and Servaes (2003) argued that if firms have a

larger agency problem, firms would hold more cash. Bao, Chan and Zhang (2012)

found a link between external control and the effect of cash flow sensitivity on cash

holdings. If the firm's shares were held by institutional investors, i.e. the firm had a

large external control and a lower agency, the effect of cash flow sensitivity on cash

holdings would be smaller.

10

CHAPTER 3: RESEARCH METHODOLOGY

3.1

The analytical framework

Increasing

investment

Firm

performance

Increasing tangible

assets

Agency problem

The sensitivity

of Cash flow

Cash holdings

Cost of holding

money

Financial

constraint

Investment

opportunities

The difficulties in

accessing capital

External capital

cost

13

3.2

The econometric models

Based on research objectives, the paper has three problems to clarify. The first is the

influence of cash flow sensitivity on cash holdings, the second is the impact of

financial constraints the last is the agency cost. Therefore, the research paper uses

three models to solve the above problems.

3.2.1 Model the effect of cash flow sensitivity on cash holdings

Based on the model of Bao, Chan and Zhang (2012), the paper uses the following

model to test the hypothesis that cash flow sensitivity affects cash holdings and this

effect is different in case the firm has negative and positive cash flow:

ΔCashHoldingsit = α0 + α1CashFlowit + α2Negit + α3Cashflowit * Negit + α4Qit +

α5Sizeit + α6Expenditureit + α7Acquisitionit + α8ΔNCWCit + α9ShortDebtit-1 + εit

(1)

Where:

CashHoldings: is calculated as the cash in company divided by total asset.

ΔCashHoldings: the difference of cash between year t and year t−1 over total assets

CashFlow: is the profit after interest, dividends and taxes payments plus depreciation

over total assets.

Neg: is the indicator variable. Neg equals zero if in that year the firm has positive cash

flow and one otherwise.

Q: represents the market capitalization of the company. Q is calculated by total of the

market value of the capital and the book value of assets minus the book value of the

capital and divided by the book value of assets.

Size: represents the scope of the company, calculated as the natural logarithm of total

assets.

Expenditure: the ratio of capital expenditures to total assets.

Acquisition: the indicator variable. If the company has no acquisition in that year,

Acquisition equals one and zero otherwise.

14

NCWC: is calculated as net non-cash working capital which equals working capital

minus cash divided by total assets.

ΔNCWC: is the difference of NCWC between year t and year t−1.

ShortDebt: is the debt in short-term weighted by total assets.

i and t refers to firm and year respectively, ε is random error term.

3.2.2 The effect of cash flow sensitivity on cash holdings is under financial constraints

After examining the effect of cash flow sensitivity on cash holdings, the study

examines how cash flow sensitivity varies between financially constrained and unconstrained firms. For that purpose, the paper uses three measures to divide the

sample into two groups.

Firstly, the paper uses the KZ index, which is based on the results of Kaplan and

Zingales (1997). The study uses the KZ index as the data for this metric corresponds

to the data in Vietnam. The KZ index is calculated as follows:

KZindex = -1.002 x CashFlow + 0.283 x Q + 3.139 x Leverage - 39.368 x Dividends 1.315 x CashHoldings

Where:

CashFlow: is the profit after interest, dividends and taxes payments plus depreciation

over total assets.

Q: represents the market capitalization of the company. Q is calculated by total of the

market value of the capital and the book value of assets minus the book value of the

capital and divided by the book value of assets.

Leverage: represents the capital structure of the firm which is calculated as the ratio of

the total debt and total assets.

Dividends: represents the dividend policy of the company which is calculated as the

cash dividends divided by total assets.

CashHoldings: is calculated as the cash in company divided by total asset.

15

The study evaluates firms via the KZ index based on Almeida et al. (2004), within a

year, firms ranked among the 33% of the highest KZ index are considered as in the

financial constraint group.

Secondly, the study uses an additional index to assess the financial constraints among

firms. This index is based on the research by Whited and Wu (2006) and is called the

WW index. Bao, Chan, and Zhang (2012) argued that the WW was more appropriate

than the KZ as firm’s characteristics in the WW were more related to the firm's

financial constraints than the KZ. The WW is more relevant than the KZ since the

WW does not include Tobin's Q. The data for calculating the WW are also consistent

with the data in Vietnam. The WW index is calculated as follows:

WWindex = -0.091 x CashFlowit - 0.062 x DIVPOSit + 0.021 x TLTDit – 0.044 x Sizeit

+ 0.102ISGit – 0.035 x SGit

Where:

CashFlow: is the profit after interest, dividends and taxes payments plus depreciation

over total assets.

DIVPOS: the indicator variable. If firm i pays dividend by cash in year t, DIVPOS is

consider as one and zero otherwise.

TLTD: is the debt in long-term weighted by total assets.

Size: represents the scope of the company, calculated as the natural logarithm of total

assets.

ISG: the industry's revenue growth rate.

SG: the growth rate of the company.

According to Bao, Chan and Zhang (2012), in a year, firms in the top 25% of the

highest WW index were considered as firms in the financial constraint group.

Finally, the study assesses whether firm is assigned to the financially constrained

group or not based on dividend payments. If a firm does not pay dividends during the

year, then the firm is considered ﬁnancially constrained ﬁrms and vice versa.

16

After dividing the sample into two groups, the equation (1) is adjusted to examine the

effect of financial constraints on the firm's cash holdings. The study is modified

equation (1) into equation (2) as follows:

ΔCashHoldingsit = β0 + β1CashFlowit + β2Negit + β3Cashflowit * Negit +

β4Constraintit + β5CashFlowit * Constraintit + β6Constraintit * Negit + β7CashFlowit *

Constraintit * Negit + β8Qit + β9Sizeit + β10Expenditureit + β11Acquisitionit +

β12ΔNCWCit + β13ShortDebtit-1 + εit

(2)

The variables in equation (2) are defined as in equation (1)

In equation (2), there is a constraint dummy variable (value of one if the firm is

considered financially constrained) and Constraint's interactive variables with

CashFlow variable, Neg dummy variable.

3.2.3 The effect of cash flow sensitivity on cash holdings is in the agency problem

To consider the impact of the agency problem, the study uses the following model:

ΔCashHoldingsit = γ0 + γ1CashFlowit + γ2Negit + γ3Cashflowit * Negit + γ4Instit +

γ5CashFlowit * Instit + γ6Instit * Negit + γ7CashFlowit * Instit * Negit + γ8Qit + γ9Sizeit

+ γ10Expenditureit + γ11Acquisitionit + γ12ΔNCWCit + γ13ShortDebtit-1 + εit

(3)

Where: Inst equals one if the number of shares held by institutional shareholders is in

the top 10% of the company.

The variables in the model are calculated as follows:

Cash holdings, in the study of Almeida et al. (2004) on cash flow sensitivity, Almeida

et al. defined the firm's cash holdings including cash and marketable securities divided

by total assets. Bao, Chan and Zhang (2012) defined cash as the firm’s total cash

holdings divided by total assets. With data taken from Vietnameses firm’s financial

statements, the study calculates cash holdings as cash and cash equivalents on the

balance sheet, i.e. the largest liquid asset item, divided by the total assets of the firm.

𝐶𝑎𝑠ℎ𝐻𝑜𝑙𝑑𝑖𝑛𝑔 =

𝐶𝑎𝑠ℎ 𝑎𝑛𝑑 𝑐𝑎𝑠ℎ 𝑒𝑞𝑢𝑖𝑣𝑎𝑙𝑒𝑛𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

17

CashHoldings: is calculated as the cash in company divided by total asset.

Cash flow, Almeida et al. (2004), Bao, Chan and Zhang (2012) defined the firm’s cash

flow as earnings before extraordinary items and depreciation divided by total assets. .

Extraordinary items or expenses are stated in the income statement. However, with

data collected in Vietnam, there are no extraordinary items in the firms' income

statement. Therefore, the study takes the variable definition according to Bates et al.

(2009), in which CashFlow variable is the profit after interest, dividends and taxes

payments plus depreciation. By this definition, the CashFlow variable is calculated as

follows:

𝐶𝑎𝑠ℎ𝐹𝑙𝑜𝑤 =

𝑃𝑟𝑜𝑓𝑖𝑡 𝑎𝑓𝑡𝑒𝑟 𝑡𝑎𝑥 𝑝𝑙𝑢𝑠 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Where: depreciation is taken from the depreciation of fixed assets on the indirect cash

flow statement.

Price to book value, known as the margin value q, was developed by Tobin (1969). In

this study, Tobin defined the margin value q as the ratio between the market value and

the replacement value of the asset. However, since the margin value q can not be

observed, the study uses the value of Tobin's Q to replace the margin value Q, which

is used in many empirical studies in the world such as Bates et al. (2009), Bao, Chan

and Zhang (2012). The value of Tobin's Q is calculated by comparing the firm’s

market capilization value with the respective book value.

𝑄=

𝑀𝑎𝑟𝑘𝑒𝑡 𝑐𝑎𝑝𝑖𝑙𝑖𝑧𝑎𝑡𝑖𝑜𝑛 + 𝐵𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑑𝑒𝑏𝑡𝑠

𝑇𝑜𝑡𝑎𝑙 𝑏𝑜𝑜𝑘 𝑣𝑎𝑙𝑢𝑒 𝑜𝑓 𝑎𝑠𝑠𝑒𝑡𝑠

Book value of debts is taken from liabilities item on balance sheet.

Market capilization equals P/B multiplied by book value of the capital ie equals

outstanding shares multiplied by price at that time.

Total book value of assets is taken from total assets item on balance sheet.

18

Capital expenditure, Riddick and Whited (2009) argued that as firm's cash flow

increased, it corresponds to an increase in the productivity of firm's tangible fixed

assets. Firms do not accumulate cash, they return cash to invest. It means firms use

cash to purchase more fixed assets when they have positive cash flow. The amount of

money a firm spending on procuring fixed assets for investment projects is called

capital expenditure, which suggests that capital expenditures may represent

investment opportunities. Based on this argument, the study calculates capital

expenditures as the difference between the firm's fixed assets in year t and t -1 plus the

fixed asset depreciation in year t and t - 1.

𝐸𝑥𝑝𝑒𝑛𝑑𝑖𝑡𝑢𝑟𝑒 =

𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑓𝑖𝑥𝑒𝑑 𝑎𝑠𝑠𝑒𝑡𝑠 + 𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑜𝑓 𝑑𝑒𝑝𝑟𝑒𝑐𝑖𝑎𝑡𝑖𝑜𝑛

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Non-cash working capital, based on the definition of Bao, Chan and Zhang (2012),

non-cash working capital is calculated as working capital minus cash divided by total

assets. Working capital equals short-term assets minus short-term debts. Cash

holdings equal cash and cash equivalents.

𝑁𝐶𝑊𝐶 =

𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑎𝑠𝑠𝑒𝑡𝑠 − 𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑠 − Cash and cash equivalents

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

ΔNCWC: is the difference of NCWC between year t and year t−1.

Short-term liabilities, according to Bao, Chan and Zhang (2012), ShortDebt variable is

calculated by taking short-term debts in year t-1 divided by total assets in year t.

𝑆ℎ𝑜𝑟𝑡𝐷𝑒𝑏𝑡 =

𝑆ℎ𝑜𝑟𝑡 𝑡𝑒𝑟𝑚 𝑑𝑒𝑏𝑡𝑠 𝑝𝑟𝑒𝑣𝑖𝑜𝑢𝑠 𝑦𝑒𝑎𝑟

𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠

Size, Bates et al. (2009) argued that there was economic benefit to the size of cash

holdings. In this study, Bates defined firm size as the natural logarithm of the firm's

total assets. This definition is also used in many other studies, such as Almeida et al.

(2004), Bao, Chan and Zhang (2012).

𝑆𝑖𝑧𝑒 = ln(𝑇𝑜𝑡𝑎𝑙 𝑎𝑠𝑠𝑒𝑡𝑠)

19

3.3

The data

Based on previous studies on cash holdings, the study selected data including 274

firms from the Hanoi Stock Exchange (HNX) and Hochiminh Stock Exchange

(HOSE). Selected firms are non-financial. The study excludes firms in the financial

sector, such as the real estate, securities and banking, insurance due to special

accounting standards, according to Shadi Farshadfar and Reza Monem (2013).

Sampling period is from 2009 to 2015. The data is presented panel data with 1918

observations. Data is collected from the financial statements of the firms which are

taken from Vietstock, CafeF.

3.4

Fixed Effects and Random Effects

The study uses the OLS regression method for the data panel as Fixed effects and

Random effects. The study ran two quantitative methods simultaneously with the

collected data. After running the regression, the study will use the Hausman test to

examine the results from the two methods to find the better results.

Hausman's test examines the results between the two regression models Fixed effects

and Random effects by examining the difference in the regression coefficient and the

null hypothesis assuming that the difference is not systematic. That is, if accepting the

hypothesis H0, the random effects are better. In contrast, rejecting the null hypothesis,

the Fixed effects are better.

If the Hausman test‘results indicated that FEM is better REM, the study will use the

results of the FE model. However, to eliminate the heteroskedasticity, the study will

use Robust and Cluster for the FE model.

Robust, when there is the heteroskedasticity, OLS estimation is still an unbiased

estimator. However, estimates are no longer effective because the variance is no

longer the smallest. Furthermore, the variance estimates will be biased, so that

significance level and confidence interval tests based on t and F are no longer reliable.

Derived from the idea that the OLS estimation when there is the heteroskedasticity,

the regression coefficient is correct, only the standard error is deviated, with the

20

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