17
Journal of Economic and Banking Studies
No.8, Vol.4 (2), December 2024 pp.17-26
©
Banking Academy of Vietnam
ISSN 2734 - 9853
Impact of financial leverage on cash holding structure:
The case of non-financial listed firms in Vietnam
Le, Hoang Vinh1 - Trinh, Ngoc Tien2
University of Economics and Law, Vietnam National University, Ho Chi Minh City
Corresponding Authors.
E-mail address: vinhlh@uel.edu.vn (Le, H.V.), tientn20404c@st.uel.edu.vn (Trinh, N.T.)
1. Introduction
Cash and cash equivalents are the basic
current asset items and appear first on
the balance sheet of companies with
the highest level of liquidity, including cash on
hand, non-current deposits, commercial se-
curities with very short maturities and are not
expected to lose significant value upon maturity
(Breitner & Anthony, 2011; Lessambo, 2022).
According to Van Gijlswijk (1987), an impor-
tant aspect of cash management is dealing with
temporary liquidity positions. This author be-
lieves that corporate financial managers want to
maximize interest rates income rather than rates
in the event of liquidity surpluses and minimize
interest costs when liquidity shortages occur.
Van Horne and Wachowicz (2008) asserted
that not all needs for cash require correspond-
ing cash reserves and part of these needs can
be met by cash equivalents and unused credit
limit. Accordingly, cash management from a
financial perspective involves effectively col-
lecting, spending and investing temporarily idle
cash. Thus, with the basic principles of financial
management, companies try to maintain target
cash balances to meet transaction needs and/
or requirements to compensate for liquidity
Chronicle Abstract
Article history The aim of this paper is to assess the impact of financial leverage on cash
holding structure represented by the proportion of cash equivalents in total
cash and cash equivalents of non-financial companies listed in Vietnam. We
selected a sample of 300 firms from the years 2015 to 2022, and analyzed
the secondary data obtained from the audited financial statements of these
companies. Through robust GLS estimation, the findings show that financial
leverage has a nonlinear effect on the cash holding structure, characterized
by an inverted U-shaped relationship. Specifically, financial leverage posi-
tively impacts the cash holding structure if they are maintained at low levels,
however this relationship turns negative at higher levels of financial lever-
age. These findings suggest that firms should manage their operations dif-
ferently based on their levels of financial leverage. Firms with low leverage
are encouraged to maintain lower cash reserves and invest in marketable
securities to optimize liquidity and profitability. Additionally, they could
consider issuing debt to enhance investment and operational capabilities,
thereby maximizing corporate value. Conversely, firms with high leverage
are advised to hold more cash and demand deposits to mitigate the risks
of financial distress and bankruptcy, as they are more susceptible to such
outcomes. Policymakers may consider implementing measures to reduce
the possibility of financial difficulties, such as reducing reliance on debt
financing and promoting equity financing opportunities.
Received
Revised
Accepted
08th May 2024
14th Sep 2024
01st Nov 2024
Keywords
Cash holding structure,
Financial leverage,
Nonlinear effect
DOI:
10.59276/JEBS.2024.12.2682
Impact of financial leverage on cash holding structure: The case of non-financial listed firms in Vietnam
18
Journal of Economic and Banking Studies- No.8, Vol.4 (2), December 2024
shortages, and at the same time, companies also
consider investing in highly liquid commer-
cial securities. Abioro (2013) concluded that
companies want to achieve liquidity goals and
better financial management efficiency, one of
the basic foundations is to establish effective
cash management policies, in which managers
must solve the problem of optimal cash reserve
balance. There are lot of prior work identify-
ing several firm-specific factors important for
firms’ cash holding decisions such as firm size,
leverage, growth opportunities, and cash flow
volatility, etc. but few studies investigate how
these micro factors affect cash holding struc-
ture - cash equivalents divided by cash and cash
equivalents, because cash equivalents not only
meet liquidity needs but also maintain profit-
ability goals with safety. Therefore, it’s neces-
sary to explore in this study.
It is widely acknowledged that financial lever-
age plays an important role in shaping the cash
policies of companies. Previous research on the
impact of financial leverage on cash holdings
likewise produced mixed results. According to
John (1993), financial leverage can serve as a
proxy for a company’s ability to raise debt, so an
inverse relationship between leverage and cash
holdings can be expected. Graham and Harvey
(2001) argued that companies can have financial
flexibility based on a reasonable balance between
holding a lot of cash and/or maintaining a low
level of debt. This balance implies the existence
of an inverse relationship between cash holdings
and financial leverage of non-financial firms.
The relationship is also confirmed by Ozkan and
Ozkan (2004), Ferreira and Vilela (2004), Tayem
(2017), Saputri and Kuswardono (2019). Howev-
er, the effects of leverage depend on the extent to
which it is used. Hovakimian and Titman (2003),
Fazzari et al. (1988) pointed out that companies
face more financial difficulties if the level of
financial leverage is higher, therefore, managers
tend to increase the amount of money they hold
to ensure the safety of the company. This em-
pirical evidence also supports the argument that
firms in a state of financial constraints have more
incentives to hold cash. Companies that maintain
high financial leverage often have many limita-
tions in mobilizing external financing, so they
tend to increase their cash reserve according to
the precautionary motive in Keynes’ (1936) the-
ory. Guney et al. (2007) and Arora (2019) have
also provided evidence of a positive relationship
between financial leverage and cash holdings in
the case of with high levels of leverage.
In Vietnam, the financial market is recognized
as an emerging market (Tran Minh et al., 2022).
Consequently, market fluctuations are substan-
tial, largely contingent upon international finan-
cial markets and macroeconomic circumstances.
As a result, issues such as the agency problem
and asymmetric information are heightened in
Vietnam, particularly due to the comparatively
weak investor protection mechanisms in place
compared to developed nations (Nguyen &
Ramachandran, 2006), so managers tend to be
opportunistic for the sake of their own interest,
therefore, it is necessary to have a mechanism
to control the behavior of company managers in
implementing cash management policies. The
control mechanism is with the use of leverage,
because high-leverage firms are more subject to
investor monitoring implying limited manage-
rial discretion and lower cash holdings. Further-
more, the Vietnamese stock market is charac-
terized by low trading volume and irregular
trading activities, indicating an inefficient and
underdeveloped market structure (Loc et al.,
2010). Moreover, the Vietnamese financial sys-
tem is predominantly bank-based, leading firms
to maintain relationships with lenders and rely
heavily on loans as their primary source of capi-
tal funding (Nguyen & Ramachandran, 2006).
According to Demirgüç-Kunt and Maksimovic
(1999), companies in emerging markets typical-
ly depend on short-term financing, a trend that
is also evident in Vietnam. Le and Phan (2017)
provided empirical evidence that Vietnamese
listed companies rely more on short-term debt
than on long-term debt. Distinctive attributes of
the Vietnamese financial market could contrib-
ute to variations in cash holding and financial
leverage across markets. The findings suggest
that disparities in legal frameworks, institutional
structures, and macroeconomic environments
might explain differences in the relationship
Le, Hoang Vinh - Trinh, Ngoc Tien
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No.8, Vol.4 (2), December 2024 - Journal of Economic and Banking Studies
between cash holdings and financial leverage.
In this paper, we evaluate the impact of fi-
nancial leverage on the mix of cash on hand
and demand deposits with cash equivalents
for the case of non-financial listed firms in
Vietnam. Finding evidence of this relationship
has important implications for managing the
combination of cash with marketable securities
according to the Baumol (1952) model, and this
helps explain why the level of cash and cash
equivalents holdings has a nonlinear effect on
firm profitability (Wibawa & Nareswari, 2020).
In addition, it also provides useful information
for financial managers in choosing management
policies for the item “cash and cash equiva-
lents” associated with the goal of a reasonable
balance between liquidity and profitability.
2. Literature review and hypothesis devel-
opment
The agency theory proposed by Jensen and
Meckling (1976) suggests that the distinction
between ownership and management rights can
lead to conflicts of interest in financial manage-
ment with the goal of increasing shareholder
wealth. Conflicts of interest between managers
and shareholders may arise from cash hold-
ings. Managers can use existing cash to finance
low-risk investments to ensure the convenience
of their work; but this limits the company’s
profitability and negatively impacts sharehold-
ers’ wealth. Managers also tend to hold more
cash in the company’s asset portfolio to facili-
tate financial management decisions or to cre-
ate opportunities to increase personal benefits
for themselves. Accordingly, companies may
maintain high debt ratios to control the agency
problem, and this may cause managers to adjust
the cash holding structure towards increasing
the amount of cash on hand and reducing cash
equivalents. Supporting the agency theory, Ahl-
gren et al. (2007) provided empirical evidence
of a negative relationship between financial
leverage and cash holdings. Accordingly, a high
financial leverage ratio provides a good signal
about the company’s ability to issue debt instru-
ments; this implies a substitution relationship
between borrowings and the total balance of
cash and cash equivalents.
The pecking order theory proposed by Myers
and Majluf (1984) is based on the existence
of information asymmetry between managers
and owners in companies. Accordingly, equity
financing is often the last choice because of its
higher costs. It causes the company to prioritize
the use of debt over new equity. Debt financing
can reduce corporate income taxes, save capital
costs and create leverage with the expectation
of increasing profitability. Therefore, this the-
ory implies that increasing the use of financial
leverage may cause a firm to choose a policy of
holding less cash, and a portion of cash on hand
and demand deposits may be converted into
cash equivalents. It is understood that increas-
ing financial leverage explains the change in
the structure of cash holdings represented by
the proportion of cash equivalents in total cash
and cash equivalents. Ferreira and Vilela (2004)
found empirical evidence that firms are able to
maintain high levels of financial leverage due
to their ability to mobilize external financing;
therefore, they can reduce their total balance of
cash and cash equivalents.
Rasyid (2020) showed that financial leverage
has a positive impact on cash holding. Accord-
ing to the indifferent EBIT-EPS model, this
relationship demonstrates that companies that
can generate EBIT that exceeds break-even
EBIT will prefer to use financial leverage with
the expectation of increasing EPS; therefore
these companies will tend to hold less cash.
Faulkender and Wang (2006) argued that small
firms in US have limited access to capital
markets, therefore increasing the level of
financial leverage makes the company choose
to hold more cash. Ozkan & Ozkan (2004) and
Almagribi et al. (2023) also concluded empiri-
cal evidence similar to Faulkender and Wang
(2006), but Ozkan & Ozkan (2004) explained
that firms with high financial leverage will
hold more cash to minimize the possibility
of financial distress. Endri et al. (2020) sup-
ported the view of holding a lot of cash for the
purpose of avoiding insolvency and financial
difficulties due to the use of debt. Bagh et al.
Impact of financial leverage on cash holding structure: The case of non-financial listed firms in Vietnam
20
Journal of Economic and Banking Studies- No.8, Vol.4 (2), December 2024
(2021) argued that companies with high levels
of financial leverage will be limited in access-
ing external financing because capital costs
increase significantly; the relationship causes
the firm to maintain increased cash reserves as
an incentive to seize new investment opportu-
nities. In addition, according to Myers (1977),
high financial leverage can lead to overinvest-
ment, and increased cash holdings can reduce
the agency costs of debt; this indicates a posi-
tive relationship between financial leverage
and cash holdings at companies.
Previous empirical studies evaluate companies’
cash holdings based on the total balance of cash
and cash equivalents. Meanwhile, the Baumol
model believes that the combination of cash
and cash equivalents is an important financial
problem for companies; and company managers
need to find the optimal combination (Baumol,
1952). Cash equivalents are not only highly
liquid assets but also provide additional income
for the company. Therefore, financial leverage
can have different impacts on the cash holding
structure (including cash and cash equivalents).
Accordingly, the first hypothesis of our paper
is that financial leverage explains the decrease
in cash on hand and demand deposits but the
increase in cash equivalents in order to balance
the liquidity and profitability goals, the follow-
ing testable hypothesis is proposed:
H1: There is a positive impact of financial le-
verage on cash holding structure represented
by the proportion of cash equivalents in the
total balance of cash and cash equivalents.
On the other hand, Drobetz & Grüninger
(2007) and Guney et al. (2007) showed that
there is a U-shaped nonlinear relationship
between the leverage ratio and cash holdings
in the case of non-financial firms. Initially,
the negative impact of financial leverage on
cash holdings supports the implication from
pecking order theory. Cash holdings decrease
when internal financing and additional debt are
insufficient for investment expansion purposes.
In addition, this relationship is also consistent
with the explanation that agency problems
are better controlled if the firm has higher
financial leverage. Beyond a certain level of
leverage, the impact of financial leverage on
cash holdings will reverse. This result supports
the hypothesis of financial distress risk due to
the use of leverage, and the company needs to
reserve more cash because of the precautionary
motive according to Keynesian theory. In ad-
dition, Guney et al. (2007) also found that the
impact of leverage on cash partly depends on
the country-specific characteristics.
In the case of Vietnamese listed firms, Tran
Minh et al. (2022) found that financial le-
verage of the previous year has a nonlinear
U-shaped impact on the total balance of cash,
cash equivalents, and short-term financial
investments. In addition, these authors found
that short-term debt and long-term debt both
have a nonlinear impact on companies’ cash
holdings. These findings support the empirical
evidence asserted by Hall et al. (2014), Nenu
and Vintila (2017), Thanatawee (2019), Guney
et al. (2007), Drobetz and Grüninger (2007).
Accordingly, financial leverage and cash hold-
ings are negatively related in cases where the
company uses little debt, and the relationship
becomes positive when the company uses a
lot of debt. However, maintaining short-term
financial investments provides a signal about
the company’s excess capital, and these assets
are expected to increase the company’s profit-
ability. Therefore, to more closely represent
the cash management of listed companies in
Vietnam, we will evaluate the combination of
cash and cash equivalents. With the goal of
evaluating the decision to hold cash and cash
equivalents in relation to the policy of using
financial leverage in the same period, we find
that cash equivalents can be maintained in
excess of cash on hand and demand deposits
if the company has a low level of debt utiliza-
tion. This leads to the existence of a positive
impact of financial leverage on cash holding
structure (including cash and cash equivalents).
But when financial leverage is high, compa-
nies will tend to reverse the cash structure for
safety purposes, minimizing the risk of finan-
cial distress. Therefore, we will test the second
hypothesis with the following content:
Le, Hoang Vinh - Trinh, Ngoc Tien
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No.8, Vol.4 (2), December 2024 - Journal of Economic and Banking Studies
H2: There is an inverted U-shaped relation-
ship between financial leverage and cash
holding structure represented by the propor-
tion of cash equivalents in the total balance
of cash and cash equivalents.
3. Methodology
3.1. Empirical model
Based on the research hypotheses established in
section 2, we developed the research model on
the impact of financial leverage on cash holding
structure in the case of non-financial companies
listed in Vietnam. Accordingly, the dependent
variable is cash holding structure (WCE), the
independent variable is financial leverage
(LEV). In addition, to increase the model’s
suitability when estimating, the authors added
four control variables, including company size
(SIZE), liquidity (LIQ), profitability (ROE)
and growth (GROW). The measurement and
expected sign of the variables in the research
model are summarized in Table 1, and the re-
gression equation in this study is as follows:
WCEi,t = β0 + β1LEVi,t + β2(LEVi,t)2+ β3SIZEi,t +
β4LIQi,t + β5GROWi,t + β6ROEi,t + εi,t
In which: β0 is an intercept, β1-6 are regression
coefficients of the independent/control vari-
ables, i and t are corresponding to each non-fi-
nancial firm and each year, ε is a random error.
3.2. Research sample and data
Utilizing purposive sampling method, this
study engages with 300 non-financial firms
listed on the Ho Chi Minh and Hanoi Stock
Exchanges spanning an 8-year period from
2015 to 2022. The selected companies in the
research sample must satisfy the following
criteria concurrently: (i) Exclusion from the
financial industry sector due to substantial dis-
parities in business activities, impacting the ne-
cessity for cash reserves, demand deposit lev-
els, and cash equivalent holdings; (ii) Provide
complete information for all variables to have
balanced panel data; (iii) All financial state-
ments used for this study were audited with an
unqualified opinion. Analysis of 2015 data is
chosen to maintain consistency in approaching
financial statement items as per Circular 200 of
the Ministry of Finance (2014), effective from
fiscal year 2015 onward.
This study uses secondary data to access the
variables in the research model mentioned
above. Accordingly, the data source is from the
financial statements to measure the variables
WCE, LEV, GROW, SIZE, LIQ, PRO. With
the mentioned research sample, this research
used balanced panel data to estimate the rela-
tionships in section 4 of this article.
3.3. Estimation method
Our study follows the sequence for panel data
including Pooled regression model (OLS),
Fixed effects model (FEM) and Random ef-
fects model (REM). Accordingly, to choose
the appropriate model, this research uses
Breusch-Pagan for Random effects, F test for
Fixed effect, and Hausman tests. The results
determined that FEM is the most suitable esti-
mation model. On the FEM estimation results,
this study performs a Wald test and shows that
the model exists heteroskedasticity problem.
Therefore, the GLS estimation method is used
to overcome this problem (Greene, 2018).
4. Research results
4.1. Descriptive statistics analysis
We performed descriptive statistical analysis of
the variables, and these results are presented in
Table 2.
Based on Table 2, all the variables in the re-
search model have 2,400 observations, so the
research data is in the form of a balanced panel.
The dependent variable WCE ranges from 0% to
99.95%, the average of 0.2841 indicates that cash
equivalents account for 28.41% of the cash and
cash equivalents account balance. This shows that
companies hold more cash and demand deposits
than cash equivalents. With the independent vari-
able LEV, the average of the sample is 47.33%
with a standard deviation of 21.81% ranging from