Doctoral Dissertation

BOARD INDEPENDENCE, FOREIGN OWNERSHIP,
AND STOCK RETURN VOLATILITY IN VIETNAM

To Anh Tho

March, 2020

Graduate School of Social Sciences
Hiroshima University

Doctoral Dissertation

BOARD INDEPENDENCE, FOREIGN OWNERSHIP,
AND STOCK RETURN VOLATILITY IN VIETNAM

To Anh Tho

Supervisor: Professor Suzuki Yoshihisa
Associate Professor Yamane Akiko

March, 2020

Graduate School of Social Sciences,
Department of Economics
Hiroshima University

TABLE OF CONTENTSACKNOWLEDGEMENTLIST OF TABLES
LIST OF FIGURESCHAPTER 1: INTRODUCTION ................................................................................ 1
1.1 The context of study .................................................................................................. 1
1.2 Background about corporate governance in Vietnam ............................................... 4
1.2.1 Historical background of Vietnamese economic transition and stock market . 4
1.2.2 Typical corporate governance characteristics of public companies in Vietnam.......................................................................................................................................... 6
1.2.2.1 The dominant role of the State ................................................................ 6
1.2.2.2 Little separation of ownership and control .............................................. 6
1.2.2.3 The increasing participation of foreign investors .................................... 7
1.3 Research questions .................................................................................................... 7
1.4 Research methods ...................................................................................................... 7
1.5 Structure of the dissertation ....................................................................................... 8
CHAPTER 2: (PAPER 1) THE RISK MANAGEMENT ROLE OF NONEXECUTIVE DIRECTORS: FROM CAPITAL EXPENDITURE PERSPECTIVE.......................................................................................................................................... 92.1. Introduction .............................................................................................................. 9
2.2 Literature review and research hypotheses .............................................................. 10
2.2.1. The role of non-executive directors ............................................................... 10
2.2.2. Capital expenditures and firm risk ................................................................ 122.2.3. The interaction of non-executive director ratio and capital expenditures ..... 13
2.3. Data and methodology ............................................................................................ 14

2.3.1 Sample ............................................................................................................ 14
2.3.2 Empirical model ............................................................................................. 15
2.4 Empirical results ...................................................................................................... 17
2.5 Conclusion ............................................................................................................... 23
CHAPTER 3: (PAPER 2) THE CHANGE IN BOARD INDEPENDENCE IN THE
PRESENCE OF FIRM RISK AND REGULATION ............................................... 25
3.1. Introduction ............................................................................................................ 25
3.2 Literature review and research hypotheses .............................................................. 27
3.2.1 The risk management role of non-executive directors ................................... 27
3.2.2 The impacts of firm risk on non-executive director ratio ............................... 28
3.2.3 The moderating effect of regulation ............................................................... 30
3.2.4 Regulations about non-executive directors in Vietnam .................................. 31
3.3 Data, variables, and methodology ........................................................................... 32
3.3.1 Research data .................................................................................................. 32
3.3.2 Measurement of variables ............................................................................... 33
3.3.3 Method of testing research hypotheses ........................................................... 35
3.4. Results and discussion ............................................................................................ 37
3.4.1 Description statistics and correlation matrix .................................................. 37
3.4.2 The impacts of firm risk and regulation ......................................................... 39
3.5 Conclusion ............................................................................................................... 46
CHAPTER 4: (PAPER 3) FOREIGN OWNERSHIP AND STOCK RETURN
VOLATILITY IN VIETNAM: THE DESTABILIZING ROLE OF FIRM SIZE 48
4.1 Introduction ............................................................................................................. 48
4.2 Literature review ...................................................................................................... 50

4.2.1. The impact of foreign ownership on stock return volatility in the Vietnam stock
market ...................................................................................................................... 50
4.2.2 Firm size, foreign ownership, and stock return volatility ............................... 52
4.3. Data and methodology ............................................................................................ 53
4.3.1 Model specification .......................................................................................... 53
4.3.2 Data .................................................................................................................. 54
4.4. Results and discussions .......................................................................................... 55
4.4.1. Descriptive statistics and correlation ............................................................. 55
4.4.2. The impacts of foreign ownership and firm size ........................................... 56
4.4.3. The destabilizing role of firm size ................................................................. 57
4.4.4. Potential endogeneity and robustness tests .................................................... 58
4.5. Conclusion .............................................................................................................. 67
CHAPTER 5: CONCLUSIONS AND IMLICATIONS ........................................... 68
5.1 Summary of main findings ...................................................................................... 68
5.2 Implications ............................................................................................................. 68
5.2.1 About the role of non-executive directors in emerging market ...................... 68
5.2.2 About the role of foreign ownership in emerging market .............................. 69
5.3 Limitations of the dissertation ................................................................................. 70
5.4 Further research ....................................................................................................... 70

ACKNOWLEDGEMENTFirst and foremost, I would like to express my gratitude to my supervisors, Professor
Suzuki Yoshihisa and Associate Professor Yamane Akiko, for their constant supports andguidance. Without their timely support and encouragement, I would not have been able
to complete my dissertation in time.
Second, the encouragement and help of my colleagues and friends I will always
treasure.
Last but especially not least, I owe the greatest debt of gratitude to my family, fortheir unconditional and continual supports during my study. My family provided a huge
incentive to complete the dissertation.

LIST OF TABLES
Table 2.1: Sample description by industry ..................................................................... 15
Table 2.2: Description statistics ..................................................................................... 17
Table 2.3: Correlation matrix ......................................................................................... 17
Table 2.4: Fixed effects regression results ..................................................................... 18
Table 2.5: Effect of overinvestment on the relationship between NON_EX and RISK1...................................................................................................................... 19
Table 2.6: Effect of overinvestment on the relationship between NON_EX and RISK2...................................................................................................................... 20
Table 2.7: Dynamic GMM regression results ................................................................ 22
Table 3.1: Description statistics ..................................................................................... 37
Table 3.2: Correlation matrix ......................................................................................... 38
Table 3.3: Fixed effects .................................................................................................. 41
Table 3.4: Random effects .............................................................................................. 42
Table 3.5: Dynamic GMM results .................................................................................. 43
Table 3.6: Robustness checks with two alternative measures of firm risk ..................... 44
Table 4.1: Description statistics ..................................................................................... 55
Table 4.2: Correlation matrix ......................................................................................... 56
Table 4.3: Industry and year fixed effects regressions ................................................... 60
Table 4.4: Industry and year fixed effects regressions with sub-samples ...................... 61
Table 4.5: Instrumental variables regressions with year and industry fixed effects....... 63
Table 4.6: Instrumental variables regressions with year and industry fixed effects for themodel including an interaction term ............................................................. 65

LIST OF FIGURES
Figure 1.1: Number of listed companies and market capitalization in Vietnam .............. 5
Figure 1.2: Overall dissertation structure ......................................................................... 8
Figure 3.1: One-tier and two-tier board structure ........................................................... 31
Figure 3.2: Industry distribution ..................................................................................... 33
Figure 3.3: The mean of firm risk and non-executive directors ratio by year from 2008 to2016 .............................................................................................................. 37
Figure 4.1: The percentage of foreign trading volume over the whole market .............. 51

BOARD INDEPENDENCE, FOREIGN OWNERSHIP, AND
STOCK RETURN VOLATILITY IN VIETNAM
CHAPTER 1: INTRODUCTION
1.1 The context of the study
Efficient corporate governance is considered as a significant mechanism to reduce
information asymmetries, thus to prevent financial crises, especially for emerging
markets. For instance, the financial crisis of 2007–2009 came from the weakness incorporate governance mechanisms in many countries (Akbar et al, 2017). Therefore, mostemerging markets have paid more proper attention to establishing a code of corporate
governance to prevent the collapse of financial markets from a lack of transparency anddisclosure in companies. Particularly, building board independence and increasing
foreign ownership to improve information transparency have become two major trends inmodern corporate governance.
In recent years, governments have had significant interests in corporate governanceand forced many firms to increase their board independence, especially for high-risk firms.
In many countries, the regulations related to the separation of ownership and management
are issued to prevent the collapse of financial markets from a lack of transparency anddisclosure in companies. For instance, in America, the Sarbanes-Oxley act (2002) and theDodd-Frank act (2010) forced companies to appoint more independent directors anddisclose more information about compensation. The Malaysian Code on Corporate
Governance formed promptly after the 1997-1998 Asian Crisis imposed the requirementon the appointment of more non-executive directors. In Vietnam, the Circular
121/2012/TT-BTC dated July 26, 2012 also provided further regulations on corporate
governance applicable to public companies. The regulations connected internal control
and risk management, identified board independence as an essential standard for risk
management process.
However, compared with developed economies, corporate governance characteristics
in Vietnamese listed companies as well as in other Southeast Asian companies may bedifferent in terms of market characteristics, economic instability, the strength of
institutions, government regulations, and so on. The dissimilarities significantly influence
the risk management role of non-executive directors.

1- It is noted that the board structure for Vietnamese listed companies is categorized as
two tiers including a management board (the lower tier) which is responsible for firms’
operation and a separate supervisory board (the upper tier) which assumes supervisory
functions as to the management and operation of the company (Belot et al., 2014). In a
two-tier board system, the supervisory board is led by a chairman while the top leader ofthe executive management board is a CEO. Such a dual board structure is popular inGermany and Netherland, while The United States and the United Kingdom provide
examples of unitary board structure which gathers both managing board and supervisoryboard in one group (Douma, 1997). However, the co-existence of management andsupervisory boards might lead to overlapping and ineffective functions in the Vietnamese
corporate governance system because the responsibilities of both boards are unclear (Buiand Nunoi, 2008).
- Specifically, Southeast Asian firms tend to exhibit concentrated ownership, whilefirms in developed countries such as the US and the UK prefer dispersed ownership(Claessens et al., 2000). In these countries, the listed firms are usually controlled byfamily shareholders or state shareholders who have a strong tie with the management
team, but the protection of minority stockholders’ rights is weaker (La Porta et al., 1996).
Non-executive directors are usually nominated or appointed by majority shareholders
who do not want to lose control of the business. In Vietnam, state ownership has stillaccounted for a significant proportion in the stock market because Vietnam historicallyinstalled a centralized economy characterized by state ownership. Besides, thegovernment uses state-owned enterprises to pursue social objectives such as optimallevels of employment or the provision of social services to the community, rather thanprofit maximization (Shleifer & Vishny, 1997). Consequently, non-executive directors inmany Vietnamese listed firms is usually dominated by the state who acts a controllingshareholder, so the risk management of non-executive directors is appreciated not to beinefficient. However, the divestment of state-owned enterprises has gradually created
opportunities to increase qualified non-executive directors on boards in recent years,
which helps to address the conflicts between controlling and non-controlling shareholders.
Notably, foreign investors tend to appoint representatives or seek experts to coordinate
and monitor corporate governance. Min & Bowman (2015) also support that foreign
investors place considerable merit on the appointment of independent directors in thefirms listed on the Korea Exchange. Thus, this dissertation will investigate and give more2

insights into the role of non-executive directors in controlling the fluctuation of stock
returns in the Vietnamese listed firms.
This purpose will be analyzed in two different dimensions:- First, the dissertation analyzes the influence of board independence on thefluctuation of the stock returns. The dissertation will further investigate this effect incompanies with excessive investment because overinvestment by controllingshareholders has become serious in many Vietnamese firms so far.
- Second, whether stock return volatility might cause a change in board independenceor not? How does the regulation might affect this relationship?
Regarding foreign ownership, the increased presence of foreign investors in many
listed firms has gradually become an inevitable trend in the era of international economic
integration, in which stock markets play a supporting role in promoting foreign capital
investments into domestic companies (Foong & Lim, 2016). Foreign ownership has, inturn, contributed to the development of capital markets and has become an essential factor
in diversifying ownership structure in many listed companies.
Under international economic integration, the gradual removal of the restrictions on
foreign ownership has boosted foreign capital inflows into the Vietnam stock market (My& Truong, 2011). Notably, the Decree No. 60/2015/ND-CP permits foreign investors to
own up to 100 percent of the equity (instead of 49 percent as promulgated before) in mostpublic Vietnamese companies, except for companies in specific restricted sectors. The
increased presence of foreign investors is expected to improve transparency for listedcompanies and hence provide stock price stabilization. However, current literature has
still had conflicting findings on the association between foreign ownership and thefluctuation of stock returns. Therefore, it drives this dissertation to investigate whether
attracting more foreign ownership can be considered as a mechanism to control stock
return volatility for Vietnamese listed firms.
More notably, foreign investors in many large listed companies in the Vietnam stock
market are usually large financial institutions. Their high proportions of equity canpromote them to become large shareholders with the opportunities to divert firm resources
for their own benefits at the expense of minority shareholders (entrenchment effect). To
hide their self-serving behaviors, entrenched large shareholders usually withhold
unfavorable information or selectively disclosing information (McConnell & Servaes,
1990), which can lead to more information asymmetries. Hence, the impact of foreign3

investors on stock return volatility in such firms should be thus evaluated with morecaution.
Instead of studying the effect of corporate governance characteristics on performance
like many previous papers, this dissertation has some differences as follows: First, thestudy focuses on two major change trends in Vietnamese corporate governance, and more
specifically, these two trends are significantly influenced by the laws of Vietnam. Second,
the impacts of corporate governance on the fluctuations of stock returns are still of little
concern from researchers in Vietnam, compared with the influence of corporate
governance on firm performance. Third, instead of only studying the one-way influenceof board independence on stock return volatility, this dissertation provides a thoroughexplanation about the role of board independence in stabilizing stock return volatility by
studying the two-way effect between these two variables. Finally, the relationshipbetween corporate governance and stock return volatility will be explained in more detailthrough the impacts of the moderating factors.
1.2 Background about corporate governance in Vietnam
1.2.1 Historical background of Vietnamese economic transition and stock market
In 1986, Vietnam began to transition the country from a centralized economy to asocialist-oriented market economy. “Equitization Program” in Vietnam started in 1992 asa part of the State-owned Company Reform Program due to the poor performance ofState-owned enterprises (SOEs). The weak financial performance of the SOEs was caused
by many different factors such as unclear objectives, poor management, budget constraint,
and so forth. Equitization was implemented by selling a part of the equity of an SOE tothe public or strategic investors to increase competitiveness and utilize external resources,
but the government didn’t lose its ultimate control over these companies.
In the 1990s, the Vietnam stock market had not yet been developed, so restructuring
was implemented by focusing on the small-sized and medium-sized SOEs, and byintegrating plural SOEs into groups. It can be said that the government was very cautious
in the first steps. For example, in 1994, 18 General Corporations and 64 particular
corporations were found by combining state-owned enterprises operating in industries
that are considered specific strategic sectors.
Since 2000, the securities market has played an essential supporting role in the SOE
equitization process because SOE equitization in Vietnam has mostly taken place throughInitial Public Offering (IPO) in the stock exchanges. In 1998, stock exchanges were4

decided to be established in Hanoi City and Ho Chi Minh City under Degree 75/1996/ND- CP on the organization and functioning of the Vietnam State Securities Commission and
Degree 48/1998/ND – CP on the securities and Vietnam stock market. Then, Degree 48
was replaced by Degree 144/2003/ND-CP on securities and Vietnam Stock market. The
Ho Chi Minh Securities Trading Center (HoSTC) was opened with only two listedcompanies in 2000 and then renamed as Ho Chi Minh Stock Exchange in 2007. Five years
later, another stock market was established in Hanoi. All the listed companies were former
state-owned companies at the end of the year 2005. In the 2000-2007 period, many
legislations were issued concerning the alignment of SOE equitization with thedevelopment of Vietnam Stock exchanges. One of them was Decision No. 238/2005/QDTT on the percentage of participation of foreign investors up to 49% in all listed securities
in Viet Nam, replacing the previous Decision No. 146/2003/QD-TT which limited foreign
ownership of listed Vietnamese companies up to 30% (raised from the prior limit of 20%
in 2000). The divestment of state-owned companies and new regulations enhanced theincreasing presence of external large investors, including foreign investors. The inflow offoreign investment became stronger when Vietnamese Securities Law was issued in June
2006 and took effect on January 1rst, 2007, providing additional rules for listing stocks,
transparency and the disclosure of information by public companies. Another reason isthat Vietnam was officially recognized by the international community as the 150th WTO
member in June 2007. The trends forced SOEs to reform their corporate governance andfinancial accounts up to international standards. After 17 years of development, the total
number of listed companies was 728, and market capitalization was 125.31 billion USD,
as shown in Figure 1.1.

800
700

634

697

687

678

728

696

684

670

140.00125.31120.00600

100.00
445

500
400

73.22

330

300
36.86

200
100

33.31
12.37

25.96

36.71

45.13

52.43

80.00
60.00

58.73

40.00
20.00

0

2008

2009

2010

2011

2012

2013

Number of listed firms

2014

2015

2016

Market capitalization (billion
USD)

Number of listed companies

Figure 1.1: Number of listed companies and market capitalization in Vietnam

2017Market capitalization (billion USD)

Source: https://data.worldbank.org
51.2.2 Typical corporate governance characteristics of public companies in Vietnam
1.2.2.1 The dominant role of the State
Although many SOEs have been equitized and converted into joint-stock companies
since 1990s, the State may hold a controlling role in many important sectors such as
including post and telecommunication, textile, shipbuilding, petrol, coal and minerals,banking and insurance in Vietnam’s economy. Government involvement in the businesssector remains extra-ordinary high, remaining the ultimate controlling shareholder inmost equitized listed State-owned enterprises (SOEs). A survey conducted by IFC (2012,p20) showed that the government held a controlling ownership of 50% or more in 31%
of all the companies surveyed. By retaining majority ownership, the State has directly
participated in corporate governance as a key shareholder and exercised its control via
the general managers. Moreover, the directors have also been appointed by the State to
the company’s Board of Directors.
Despite playing the role of a majority shareholder, the State has not generated morepositive outcomes in the Corporate Governance Scorecard results, especially comparedto those companies with high foreign ownership. In the context of highly concentrated
ownership by the State and by other majority shareholders as well as the weak legal
system, minority shareholders of Vietnamese-listed firms are less protected. Therefore,
Vietnamese firms show frequent conflicts between majority and minority shareholders,which is usually found in other transition economies (Bebchuk & Hamdani, 2009;
Claessens et al., 2000). The intervention by the State with its multiple objectives andbureaucratic management is likely to cause agency problems in Vietnamese firms.
1.2.2.2 Little separation of ownership and control
In Vietnam, most controlling shareholders act as executive directors. Failure to
separate ownership and control typically results in weak accountability and control
structures, abusive related party transactions, and inadequate information disclosure. The
concept of Board of Directors was first introduced in the Company Law in 1990 and theLaw on SOEs in 1995, but the concept of non-executive directors was not taken seriously
until recently, when the Vietnamese government issued the Circular 121/2012/TT-BTC
dated July 26, providing further regulations on corporate governance applicable to publiccompanies. It is the first official legal document to define the concept of non-executive
directors in Vietnam, which has significantly increased board independence. However,the controlling shareholders have still taken control of the whole companies, so they havenominated or appointed non-executive directors who are closely related to them.
6

Therefore, non-executive directors are said to be advisors other than supervisors in
Vietnamese listed firms.
1.2.2.3 The increasing participation of foreign investors
The transition of the Vietnamese economy from state ownership to a market systemand the reform of the stakeholder governance structure is premised on the successcorporate governance codes in developed countries. The Vietnamese government’s
strategy for enhancing corporate governance codes towards the international standards is
to attract foreign investment capitals into Vietnamese firms. Especially, the integration ofVietnam into WTO - the World Trade Organization, has allowed for a significant increasein foreign ownership since 2007.
1.3 Research questions
This dissertation aims to answer the following research questions:
1. What is the impact of non-executive directors on stock return volatility in Vietnam?
How is the influence of the non-executive director ratio on stock return volatility in firms
with overinvestment? (Chapter 2)
2. Do firms with more stock return volatility increase or decrease the non-executive
director ratio? What is the impact of regulation on this association? (Chapter 3)
3. What is the impact of foreign ownership on stock return volatility in Vietnam? How
is the influence of foreign ownership on stock return volatility in large firms? (Chapter 4)
1.4 Research methods
The dissertation answers the three above research questions by investigating nonfinancial listed firms in the Vietnam stock market during the period from 2007 to 2017.
Corporate governance data (for example, the proportion of independent directors, board
size, state ownership, foreign ownership, and so forth) was manually collected frompublished annual reports. If there were any missing observations in the panel data, thedata collected on www.ezsearch.fpts.com.vn, www.stockbiz.vn, www.vietstock.vn (Theyare leading websites providing financial information, market data, and investing tools for
institutional and individual investors in Vietnam) are considered as supplementary
information.
This study mainly uses the fixed effects estimation to examine the impacts of board
independence and foreign ownership on stock return volatility. The lag variable ofindependent variables, the instrumental variables fixed effects, and GMM estimation areused to further control for endogeneity. Besides, the study also conducts some additional7

robustness checks by using alternative measures of dependent variables or splitting theoriginal sample into sub-samples to make sure that the results are not spurious.
1.5 Structure of the dissertation
The structure of this dissertation is organized as follows. Chapter 1 provides anintroduction about the dissertation. Chapter 2 investigates the impact of non-executive
director ratio on stock return volatility, particularly in underinvesting and overinvesting
firms. Chapter 3 examines whether board independence is affected by firm risk andregulation. Chapter 4 analyzes the impact of foreign ownership on stock return volatility
and the destabilizing role of firm size on this relationship. Finally, the conclusions are
summarized in chapter 5.
Figure 1.2: Overall dissertation structure
Two major change trends in Vietnamese corporate governanceForeign ownership

Regulation

Stock return volatility

8Paper 3Paper 1

Capitalexpenditure

Paper 2Non-executive directors

Firm size

CHAPTER 2: (PAPER 1) THE RISK MANAGEMENT ROLE OF NONEXECUTIVE DIRECTORS: FROM CAPITAL EXPENDITURE PERSPECTIVE
2.1. Introduction
Unlike developed economies, developing countries, especially Southeast Asian
countries, have had ineffective corporate governance practices. The weaknesses incorporate governance mechanisms had an important effect on the stock market declines
in the Asian crisis (Johnson et al., 2000; Cheah & Lee, 2009). The establishment of agood corporate governance code has become a significant concern for many governments
to prevent financial crises, which usually result from a lack of transparency and disclosurein many companies. Nonetheless, the studies from developed countries may not beapplicable in developing countries because many different factors often fall beneathcontextualization, such as the structures of corporate ownership, the strength of
institutions, legal and government intervention, and so on.
Notably, the unclear separation of control and management, one of the mostnoticeable characteristics in Southeast Asian firms’ corporate governance systems, has
become a major obstacle to monitoring and thus led to potential risks. Therefore, theVietnamese government issued the Circular 121/2012/TT-BTC dated July 26, providing
further regulations on corporate governance applicable to public companies. It is the first
official legal document to define the concept of non-executive directors in Vietnam,
which has an effect of significantly increasing board independence. Although the increasein non-executive director ratio is appreciated as a big step in reforming the board structure
towards enhancing transparency, the monitoring role of non-executive directors in
Vietnamese listed companies may still be not effective since non-executive directors inemerging markets are often are appointed for reasons other than monitoring (Haniffa &Cooke, 2002). Majority shareholders often interfere with the appointment of nonexecutive directors to strengthen their control of the company. Consequently, nonexecutive directors can hardly influence important decisions and gradually play the roleof advisors other than supervisors.
Besides, corporate risk in some industries may also come from poor control ofinvestment spending, in which capital expenditure is likely to be one of the importantfactors (Amir & Livne, 2007). One of the reasons for the excessive capital expendituresin Vietnamese listed firms may be due to the agency problems between majority andminority shareholders. As supported in many previous studies, the potential agency
9conflicts in Asian markets are more likely to be large shareholders versus small
shareholders, rather than shareholders versus management. Majority shareholders havean incentive to use their control rights to divert funds and resources to other companies
or projects they control. In addition to the improved regulation on the separation between
ownership and management, the appointment of qualified independent directors has
attracted the interests of non-controlling shareholders to partially prevent the selfbehavior of entrenched majority shareholders. However, until now, only a few papers
examine the direct relationship between capital expenditures and firm risk as well as the
combined effect of board characteristics and capital expenditures on firm risk.
This paper is conducted with a sample of 151 listed companies on Vietnamese stock
markets from 2007 to 2016, for investigating the impact of non-executive director ratio
on firm risk in the presence of overinvestment. Overall, there is a positive relationshipbetween non-executive ratio and firm risk, indicating that the increase in non-executive
directors makes stock returns more volatile. This result supports the hypothesis that the
information and council of executive directors on boards are more critical to perform
efficiently (De Andres & Vallelado, 2008). However, the risk management role of nonexecutive directors is not completely denied because the incorporation of non-executive
directors and capital expenditures has a negative impact on firm risk. It means thatcompanies should maintain boards with a high proportion of non-executive directors to
reduce risks in the presence of overinvestment.
The remainder of this paper is organized as follows. Section 3.2 provides the literatureand develops hypotheses. The research design is explained in Section 3.3. Section 3.4
presents the results of the empirical analysis. The conclusions are summarized in the lastsection.
2.2 Literature review and research hypotheses
2.2.1. The role of non-executive directors
The role of non-executive directors in risk management has been supported by many
theories. Under the agency theory, more non-executive directors on board are generally
expected to be effective in providing oversight of firm performance and limiting
managerial opportunism (Jensen & Meckling, 1976; Fama, 1980; Persons, 2006). Nonexecutive directors may protect shareholders’ interests by affecting important board
outcomes and enhancing comprehensive financial disclosures (Lefort & Urzúa, 2008;
Chen & Jaggi, 2000). In addition to the supervising function, a board of directors also
10

plays a role as primary linkage mechanism that helps a firm to access important resources,
link with its external environment, and overcome adverse environmental conditions(Hillman & Dalziel, 2003). Therefore, from the perspective of resource dependence
theory, non-executive directors may provide strategic directions and influence managerial
decisions thanks to their expertise, prestige, and contacts (Pearce & Zahra, 1992; Graceet al., 1995). Furthermore, non-executive directors usually serve as external monitoring
and advising specialists in directorship market, and consequently they need to protect
their reputation under reputation theory (Fama & Jensen, 1983). This is the reason why
non-executive directors tend to support less risky projects or pursue the risk-reducing
strategies of corporate diversification (Baysinger et al., 1991; Pathan, 2009).
On the contrary, many previous studies suggest that the increasing presence of nonexecutive directors is unlikely to bring proper supervision (Raheja, 2005; Kim et al.,2014; Baysinger & Hoskinsson, 1990). According to Baysinger and Butler (1985), toomuch monitoring by outside directors could have a negative influence on shareholder
value because too intense supervision may also result in managers’ more risk-aversion
and underinvestment behavior (Hoskisson et al., 2009). Secondly, executive directors
may be better monitors because of being better informed about the firm’s constraints andopportunities than outside directors (Baysinger & Hoskinsson, 1990). Thanks to theirfirm-specific information, they efficiently deal with problems arising from information
asymmetry between the directors and managers (Raheja, 2005). According to Maug
(1997) and Kim et al. (2014), it is costly to transfer firm-specific information to outsiders
when these firms have higher information asymmetry. Dahya et al. (1996) and Rechner& Dalton (1991) also suggest that reinforcing responsibility and authority to executive
directors can enhance effective performance, rather than appointing more non-executive
directors on boards. Finally, there is a little doubt about the monitoring role of nonexecutive directors, especially for firms in developing countries, because non-executive
directors are often nominated or appointed by majority shareholders who take control of
the company.
In Vietnam, although Vietnam Enterprise Law, which was enacted in 2005,
mentioned executive directors, non-executive directors, and independent directors, thedifferentiation among them was not clarified (Minh & Walker, 2008). Two years later,
they were ambiguously categorized into: (i) executive directors, and (ii) non-executive
and independent directors in Decision 15/2007/QD-BTC of the Finance Minister on the
Model Charter of listed companies (Model Charter 2007) and Decision 12/2007/QD-BTC
11

of the Finance Minister on Code of Corporate Governance for Listed Companies on Stock
Exchange/Securities Trading Centers, but there was no specific definition of the term
“non-executive and independent directors”. Until 2012, the Circular 121/2012/TT-BTC
on July 26, providing further regulations on corporate governance applicable to publiccompanies, has been considered to be the first official legal document to define nonexecutive directors as a member of the supervisory board and not be the general manager,
deputy general manager, chief accountant or any other managers appointed by thesupervisory board (because the board structure of companies listed on Vietnamese stock
markets is categorized into two tiers including a management board and a supervisoryboard). The delays in issuing relevant regulations make the supervisory role of nonexecutive directors not highly appreciated in risk management. Besides, the appointmentof non-executive directors in many companies is often interfered with by controllingshareholders, and thus non-executive directors usually do not have many incentives tomonitor. In these companies, they often act as advisors or consultants to the majority
shareholders. Hence, this study expects that the presence of more non-executive directors
can lead to higher firm risk.
H1: The proportion of non-executive directors has a positive impact on firm risk.
2.2.2. Capital expenditures and firm risk
According to previous studies, there is a positive association between capital
expenditure and financial performance (Lev & Thiagrajan, 1993; McConnell &Muscarella, 1985; Fama & French, 1999; Mak & Kusnadi, 2005). Lev & Thiagrajan(1993) state that capital expenditure is a significant signal required by the analysts inforecasting future profitability and stock returns. Therefore, investment in capital
expenditures is expected to generate high future returns, and consequently, increasefinancial performance. Mak & Kusnadi (2005) also find that firms with higher capital
expenditures have higher accounting performance. McConnell & Muscarella (1985)
report that the announcement of an increase (decrease) in capital expenditures shouldhave a positive (negative) impact on the stock price.
In major studies on the impact of investment on corporate risk, capital expenditure is
only mentioned as an object of comparison with R&D spending. Although capital
expenditures are considered as lower-risk investments (Bhagat & Welch, 1995; Kothari
et al., 2002), the positive impact of capital expenditures on earnings variability is still
confirmed for a sample of roughly 50,000 US firm-year observations from 1972–1997 by
12

Kothari et al. (2002). Meanwhile, earnings variability has historically been found to beclosely associated with market-based measures of firm risk (Ryan, 1997; Dhaliwal et al.,2017). Amir & Livne (2007) also use both operating income variability and monthly stock
return variability as the dependent variables to prove that investments in capital
expenditures are likely to be key and hence more closely linked to business risk for manyindustries. Therefore, the positive association between capital expenditures and firm risk
is expected in this paper.
H2: A high level of capital expenditures has a positive impact on firm risk.
2.2.3. The interaction of non-executive director ratio and capital expenditures
As mentioned in many research papers related to corporate governance in developed
markets, lack of monitoring can increase opportunities for executives to pursue
overinvestment strategies to enhance their positions or to maximize their own utility atthe expense of shareholders (McConnell & Muscarella, 1985; Titman et al., 2004). It isbecause overconfident executives usually overestimate returns to investment projects, andthus overinvest when they have abundant cash holdings (Malmendier & Tate, 2005).
Regarding internal control’s role in standardizing corporate investment behavior, strong
internal control mechanisms should reduce the likelihood that overinvestment becomes asevere problem (Boot, 1992). Notably, the presence of outside directors on boards might
help mitigate managerial optimism problems and hence reduce the investment distortions
inherent to managerial overconfidence (Heaton, 2002). By using the interaction between
the proportion of non-executive directors and investment, Chung et al. (2003) also find asignificant and positive correlation between firm value and investment, as measured byboth capital and R&D expenditures, for firms with a high proportion of outside directors.
However, overinvestment caused by shareholder-manager conflicts in emerging
markets can be addressed by ownership concentration (Demsetz & Lehn, 1985; Grossman& Hart, 1986). This is considered a benefit of ownership concentration especially incountries with weak legal protection (La Porta et al., 1998). However, high levels ofconcentration between ownership and control might also lead to sub-optimal investment
or overinvestment (Andres, 2008). Because concentrated ownership can cause conflicts
between majority and minority shareholders, and in that case, majority shareholders will
use their control rights to maximize their own interest at the expense of other shareholders(Shleifer & Vishny, 1997). In other words, they have an incentive to pay out a larger
proportion of company cash flows to themselves instead of evenly distributing funds
13among all shareholders. One possibility to do so could be to redirect funds to othercompanies they control.
Consequently, the board structure reform of listed companies in Vietnamese stock
markets tends towards increasing board independence when minority shareholders andinvestors realize that overinvestment might threaten their interests. Firstly, the selectionof qualified non-executive directors is also relevant for the protection of minority
shareholders with respect to the agency costs of majority shareholders (Wright et al.,2013). Secondly, minority shareholders and investors gradually acknowledge theimportance of NEDs in monitoring and evaluating the supervisory board 's transparency
and reliability (Chang et al., 2006). In fact, a higher proportion of non-executive directors
on board could be seen as a significant restructuring of top management under the
Circular 121/2012/TT-BTC applicable to listed companies in Vietnamese stock markets(Nguyen & Phan, 2016). It helps to bring confidence to investors, lenders, and minority
shareholders, especially for overinvesting companies.
H3: More non-executive directors are needed to control firm risk in the presence ofoverinvestment
2.3. Data and methodology
2.3.1 Sample
The research sample comprises of 151 non-financial companies listed on Vietnamesestock markets (including HNX - Hanoi Stock Exchange and HOSE - Hochiminh Stock
Exchange) from 2007-2016. According to the Industry Classification Benchmark (ICB)
2008 applied in Vietnam, the list of publicly listed companies on the two markets (HOSE
and HNX) is classified into 10 industry sectors: (1) Oil & Gas; (2) Basic materials; (3)Industrials; (4) Consumer goods; (5) Healthcare; (6) Consumer services; (7)Telecommunications; (8) Utilities; (9) Financials (including banks, securities companies,
insurance companies, real estate and financial services companies); (10) Technology.
Financial companies such as banks, securities, insurance, and financial services are
excluded from the sample because they act as market makers, and more specifically, theboard structure of these companies must comply with some regulations from the statebank. The year 2007 is chosen as the starting year because Vietnamese Securities Law,
which prescribes additional rules for listing stocks, transparency and the disclosure of
information by public companies, was issued in June 2006 and took effect on January
1rst, 2007. Meanwhile, the paper also collects data about sales growth to measure14

managerial overinvestment; therefore, financial reports in 2006 are very necessary. The
total numbers of listed financial and non-financial companies on two securities trading
center HNX and HOSE in 2006 are 87 and 106, respectively. Hence, the selected sample
is highly representative.
Data for this paper are collected by reviewing annual reports which are available on
http://ezsearch.fpts.com.vn/. The industry classification is provided on www.stockbiz.vn.
They are leading websites providing financial information, market data, and investing
tools for institutional and individual investors in Vietnam.
Table 2.1: Sample description by industry
Industry

Number of firms

Percent

Basic materials

12

7.95

Consumer goods

38

25.17

Consumer services

12

7.95

Health care

6

3.97

Industrials

54

35.76

Oil & Gas

1

0.66

Real estate

14

9.27

Technology

6

3.97

Utilities

8

5.30

Total

151

100.002.3.2 Empirical model
The impact of non-executive director ratio on firm risk and the moderating role ofcapital expenditure are tested by using the following regression model:  ୧୲ = Ⱦ଴ + Ⱦଵ ̴୧୲ + Ⱦଶ  ୧୲ + Ⱦଷ ୧୲ + Ⱦସ ୧୲ +Ⱦହ  ୧୲ + Ⱦ଺  ୧୲ + Ⱦ଻  ୧୲ + Ⱦ଼ ̴୧୲ ‫ כ‬୧୲ + ɂ୧୲ (2.1)
Following Cheng (2008), Nakano & Nguyen (2012), and Wang (2012), the paper uses
daily stock returns as a basis for calculating the annual firm risk. RISK1 (Total risk)
equals the annualized standard deviation of daily stock returns. RISK2 (Idiosyncratic risk)
equals the standard deviation of the residuals estimated from the model: Ri,t = αi + βiRMt+ εi,t (where, Ri,t donates the daily stock returns; RMt represents the daily market returns
based on the VN-index; the εi,t stands for the residuals).
While Florackis & Ozkan (2009) and De Andres & Vallelado (2008) calculate nonexecutive director ratio (NON_EX) as the number of non-executive directors divided by
the total members in a one-tier board, this paper measure this variable by dividing the15

number of non-executive directors by total supervisory board members because the board
structure of companies listed on Vietnamese stock markets is separated into two tiers:
supervising board and managing board. By applying this measure, this paper may
evaluate the impact of the non-executive director ratio on firm risk more properly after
controlling for the change of managing board members. In addition, non-executive
directors are required to retain their seats for more than six months in a fiscal year toensure that their involvement can have an impact on the performance.
Capital expenditure (CAPEX) is the change in fixed assets plus depreciation scaled
by total assets at the beginning of the fiscal year. Huang & Wang (2015) use this ratio asa control variable to investigate the effect of board size on the variability of firm
performance while Mak & Kusnadi (2005) consider it as a determinant of firm
performance.
The regression models incorporate some control variables that previous studies
suggest might affect firm risk. Firm size (FSIZE) is calculated as the natural logarithm oftotal assets. It is selected as a control variable because large firms have more advantages
in attracting additional resources, and therefore "larger businesses tend to have larger
pools of financial and managerial resources that help overcome problems that threaten
their survival" (Mitchell, 1994). Malkiel & Xu (1997) also find a negative relation
between idiosyncratic risk and firm size. Price to book value (PB) is the ratio of themarket value of equity to the book value of equity. Fama and French (1992) suggest that
PB may reflect the firm risk. Debt maturity (STDEBT), measured as short-term debt
divided by total debt, plays a significant role in reducing agency costs by increasing
frequency of monitoring from lenders to managerial actions, and thus enhance
information transparency (Ranjan & Winton, 1995; Datta et al., 2005). Based on theagency arguments, firms with more short-term debt are expected to be associated with alower risk. Cash ratio (CASH) is calculated as the ratio of cash and equivalent cash tototal assets. Tufano (1998) shows that firms can implement risk management programsby managing internal cash surpluses and shortages. Dividend payment (DIV) is the ratioof dividend payout to total assets (Jiraporn et al., 2011). Pastor & Veronesi (2003) andBartram et al. (2012) indicate the negative association between dividend payment andcorporate risk. Paying more dividends to reduce the cash in hand is usually considered asa mechanism to avoid overinvestment and consequently mitigate agency problems
between managers and shareholders (Lewellen & Emery, 1981).

16

2.4 Empirical results
Table 2.2: Description statistics
RISK1
RISK2
NON_EX
FSIZE
PB

Obs

Mean

Std.
Dev.

5th
percentile

25th
percentile

50th
percentile

75th
percentile

95th
percentile

1405
1405
1510
1510
1370

0.031
0.029
0.631
13.215
1.294

0.009
0.009
0.178
1.340
1.251

0.018
0.017
0.333
11.111
0.280

0.025
0.023
0.571
12.292
0.590

0.030
0.028
0.600
13.153
0.940

0.036
0.034
0.800
14.006
1.540

0.047
0.046
0.857
15.651
3.380

STDEBT
1510
0.829
0.222
0.313
0.730
0.935
0.992
1.000
CAPEX
1510
0.070
0.174
-0.055
0.005
0.030
0.093
0.304
CASH
1510
0.105
0.113
0.007
0.029
0.066
0.147
0.332
DIV
1510
0.033
0.044
0.000
0.001
0.021
0.044
0.116
Notes: The table presents descriptive statistics among the variables of this study, where RISK1 is total risk,
RISK2 is idiosyncratic risk, NON_EX is the percentage of non-executive on the supervisory board, FSIZE
is natural logarithm of total assets, PB is the market value to book value of equity, STDEBT is the ratio ofshort-term debt to total debt, CAPEX is the change in fixed assets plus depreciation scaled by total assets
at the beginning of the fiscal year, CASH is calculated as cash and equivalent cash divided by total assets,
DIV is the ratio of dividend payout to total assets.

Table 2.3: Correlation matrix
RISK1

RISK2

NON_EXFSIZEPBSTDEBTCAPEX

NON_EX-0.057-0.033

FSIZE-0.379-0.449

0.122

PB

0.041

0.028

0.010

0.054

STDEBT-0.0060.053-0.012-0.326

0.032

CAPEX

0.121

0.045

-0.028

0.036

0.117

-0.163CASH-0.092-0.0780.066-0.012

0.159

0.167

-0.012DIV-0.199-0.2020.058-0.084

0.282

0.176

-0.003

CASH

0.362

Note: Variables are defined the same as in Table 2.2

Descriptive statistics of the research variables are presented in Table 2.2. The average
total risk (Idiosyncratic risk) of companies listed on Vietnamese stock markets is 3.1%
(2.9%). The average proportion of non-executive directors is around 63.1%. It means thaton average there are from 3 to 7 non-executive directors serving on a supervisory board
because the total number of members on this board for listed companies must comprise 5
to 11 members (under article 30 of Circular 121/2012/TT-BTC). The mean capital
expenditure ratio is 7%, which is not much different from the reported figure (4.8%) in
the research by Huang & Wang (2015) for Chinese firms over the period 2003-2011.
Table 2.3 presents the correlation matrix among the variables. The correlations
between NON_EX and RISK1/RISK2 are -0.057 and -0.033, respectively. They
demonstrate the role of non-executive directors in controlling firm risk. Meanwhile, the17correlation with CAPEX is positive, which indicates that capital expenditures cause thevolatility of stock returns. Because all the correlation coefficients are lower than 0.8, themodel is not at risk of violating multicollinearity (Gujarati, 2003).
Table 2.4: Fixed effects regression results
RISK1
NON_EXFSIZEPBSTDEBT
CAPEX
CASH
DIV

0.00621***(2.82)-0.00274***(-3.49)0.000396(1.09)-0.00171(-1.03)0.00209**(2.14)
0.00396(1.45)-0.0164**(-2.53)

NON_EX*CAPEX
Constant

0.0675***(6.52)
Yes
Yes

RISK2
0.00702***(3.08)-0.00269***(-3.46)0.000390(1.09)-0.00130(-0.77)0.00997**(2.39)
0.00401(1.47)-0.0167***(-2.62)-0.0116**(-2.08)0.0659***(6.35)
Yes
Yes

0.00535***(2.64)-0.00339***(-4.27)0.000407(1.06)-0.00150(-0.91)0.00157(1.54)
0.00462*(1.67)-0.0203***(-3.17)0.0740***(7.08)
Yes
Yes

0.00598***(2.86)-0.00335***(-4.26)0.000402(1.06)-0.00118(-0.71)0.00768*(1.95)
0.00466*(1.68)-0.0205***(-3.24)-0.00902*(-1.73)0.0728***(6.93)Yes
Yes

Year fixed
Firm fixed
Model fits:
Within R2
0.23660.23870.126301278
Between R2
0.25380.24820.3736
0.3698Overall R2
0.24390.24290.25230.2511
F-statistics
17.19***
17.60***
7.47***
7.46***
Hausman test
0.00030.00020.01580.0097
Obs
1360
1360
1360
1360
Note: Variables are defined the same as in Table 2.2. Robust t-statistics adjusted for firm-level clustering
are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

Table 2.4 shows the results of the fixed effects estimations. After controlling for serial
correlation and heteroskedasticity by using clustered standard errors, firm risk is generally
higher when companies have more capital expenditures, as the coefficients on CAPEX
fetch a positive sign and are statistically significant (except for the result in column 3).
This finding is consistent with Kothari et al. (2002) and Amir & Livne (2007) that show
the positive impact of capital expenditure on corporate risk. Table 2.4 also displays the
positive coefficients on NON_EX, indicating that firm risk will increase as the proportionof non-executive directors increases. They are statistically significant at 1% level under18

both risk measures, providing strong evidence to support the findings of Adams &Ferreira (2007) and Raheja (2005) that companies face high monitoring costs when they
increase the number of non-executive directors on board. It is because non-executive
directors do not engage in the day-to-day management of the organization. In addition,
the appointment of non-executive directors in some listed companies is usually interferedwith by majority shareholders who take control of the company, so the monitoring
activities from non-executive directors to resolve disputes between owners and managers
become less important.
Table 2.5: Effect of overinvestment on the relationship between NON_EX and RISK1
Dependent
variable
RISK1
NON_EXFSIZEPBSTDEBT
CAPEX
CASH
DIV
NON_EX*CAPEX
Constant

OVERINV = 1

OVERINV = 0(OVERINV1)(OVERINV2)(OVERINV1)(OVERINV2)

0.00596*(1.72)-0.00382**(-2.48)-0.000491(-1.01)-0.0000638(-0.02)0.0195***(2.81)
0.00883**(2.20)-0.00216(-0.23)-0.0228**(-2.26)0.0798***(3.89)
Yes
Yes

0.00776**(2.39)-0.00372***(-3.15)0.000377(0.80)
0.000471(0.17)
0.0145**(2.19)
0.0101**(2.27)-0.0229**(-2.34)-0.0188**(-2.13)0.0775***(5.02)
Yes
Yes

0.00837***(2.96)-0.00167*(-1.66)0.000113(0.20)
0.000111(0.05)-0.00178(-0.19)-0.00115(-0.37)-0.0174*(-1.75)0.00530(0.38)
0.0532***(3.92)
Yes
Yes

0.0116***(3.79)-0.00118(-0.79)0.000358(0.83)-0.00383(-1.53)-0.00391(-0.46)-0.00285(-0.91)-0.0123(-1.31)0.00330(0.24)
0.0466**(2.30)Yes
Yes

Year fixed
Firm fixed
Model fits:
Within R2
0.25690.27660.18580.2213
Between R2
0.1726
0.19650.25400.0896Overall R20.22030.22290.21230.1704F-statistics
9.38***
10.52***
9.60***
7.25***
Obs
501
685
764
675
Note: Variables are defined the same as in Table 2.2. OVERINV1 and OVERINV2 are dummy variables
used to divide the sample into overinvesting firms (OVERINV=1) and underinvesting firms(OVERINV=0). Robust t-statistics adjusted for firm-level clustering are reported in parentheses. ***, **,and * denote significance at the 1%, 5%, and 10% levels, respectively.

19

Table 2.6: Effect of overinvestment on the relationship between NON_EX and RISK2
Dependent variable
RISK2

OVERINV = 1(OVERINV1)(OVERINV2)OVERINV = 0(OVERINV1)(OVERINV2)NON_EX

0.00449(1.42)-0.00476***(-3.23)-0.000626(-1.13)-0.000108(-0.04)0.0175***(2.65)
0.00857*(1.88)-0.00759(-0.79)-0.0198*(-1.98)0.0846***(4.25)
Yes
Yes

0.00760***(2.90)-0.00251**(-2.42)-0.0000738(-0.14)0.000354(0.17)-0.00426(-0.47)-0.000185(-0.06)-0.0200**(-2.05)0.00727(0.53)
0.0567***(4.12)
Yes
Yes

FSIZE
PB
STDEBT
CAPEX
CASH
DIV
NON_EX*CAPEX
Constant

0.00697**(2.30)-0.00491***(-4.34)0.000395(0.76)-0.0000816(-0.03)0.0132**(2.19)
0.0114**(2.43)-0.0275***(-2.95)-0.0174**(-2.20)0.0912***(6.07)
Yes
Yes

0.0103***(3.53)-0.00130(-0.88)0.000355(0.75)-0.00285(-1.15)-0.00442(-0.47)-0.00273(-0.86)-0.0150(-1.53)0.00295(0.20)
0.0459**(2.32)Yes
Yes

Year fixed
Firm fixed
Model fits:
Within R2
0.10880.18210.07420.1191
Between R2
0.24280.29820.36490.1247Overall R2
0.21240.24120.25100.1443F-statistics
3.27***
5.50***
3.38***
3.32***
Obs
501
685
764
675
Note: Variables are defined the same as in Table 2.2. OVERINV1 and OVERINV2 are dummy variables
used to divide the sample into overinvesting firms (OVERINV=1) and underinvesting firms (OVERINV=0).
Robust t-statistics adjusted for firm-level clustering are reported in parentheses. ***, **, and * denotesignificance at the 1%, 5%, and 10% levels, respectively.

However, the risk management role of non-executive directors is not completelydenied because the estimated coefficients on the interaction terms between NON_EX andCAPEX turn out to be significantly negative at 5% level and 10% level. They demonstrate
the moderating role of capital expenditures in the relationship between non-executive
directors and firm risk. More remarkably, the absolute values of these coefficients are
greater than those of NON_EX and CAPEX. All suggest that a higher proportion of nonexecutive directors tends to weaken the volatility of stock returns in case that companies
increase investment. In other words, maintaining a high proportion of non-executive
directors in firms with more capital expenditures are likely to be effective in reducing
firm risk. Hausman tests are also reported in Table 2.4. They indicate that the fixed-effects
models are preferred to the random-effects models.
20

To investigate the final hypothesis in more detail, the original sample is divided into
two groups: firms with overinvestment and firms with underinvestment. In this paper, twomeasures of overinvestment are conducted as follows:
Measure 1: According to Biddle et al. (2009) and Gomariz & Ballesta (2014),
overinvestment is measured based on the deviation from the regression model:it = Ⱦ଴ + Ⱦଵ ̴ it-1 + ɂit(2.2)

it is the capital expenditure of company i for year t, and ̴ it-1 is thegrowth rate of sales during the last year. The paper conducts Eq. (2.2) regression crosssectionally for each industry-year and define the first variable overinvestment(OVERINV1) as a dummy variable that takes on the value of 1 if the residual is positive,
and 0 otherwise.
Measure 2: The second overinvestment (OVERINV2) is also a dummy, which takeson the value of 1 if the capital expenditure ratio in a company is more than the medianindustry-year adjusted capital expenditure ratio, and 0 otherwise. This measure follows
the approach developed by Bates (2005), which determines whether firms overinvest bycomparing the capital expenditure ratios of each firm operating in a given industry in agiven year with the median ratio of all firms operating in the same industry during thatyear.
The estimates presented in Table 2.5 and 2.6 show that increasing board independencein firms with overinvestment help to control firm risk. For firms with underinvestment(OVERINV = 0), the non-executive director ratio is strongly and positively associatedwith firm risk at the significance level of 1% under two risk measures. On the other hand,the coefficients on NON_EX are still positive but weakly significant for firms withoverinvestment. Moreover, the coefficients on NON_EX have smaller absolute values forfirms with overinvestment. One possible explanation is that companies seem to pay more
attention to the role of non-executive directors as they have more capital expenditures.
Regarding the interaction term, its coefficients are only negatively significant when
OVERINV variables take on the value of 1. Furthermore, the absolute values of thesecoefficients are greater than those of NON_EX and CAPEX. As expected, these results
are in line with the third hypothesis.
All the above results support that excessive capital spending in some firms poses risks
to non-controlling shareholders who tend to demand increased supervision from nonexecutive directors to minimize losses for themselves. In addition, increasing the presenceof non-executive directors can also be explained under the resource dependence theory
21

that outside directors serve to coordinate organizational action, and provide external links
to reduce risk (Hillman & Dalziel, 2003), especially for firms with many investment
activities. In contrast, the increase in the proportion of non-executive directors in case ofunderinvestment only makes the costs outweigh the benefits of monitoring, resulting inincreased risk.
Table 2.7: Dynamic GMM regression results
RISKt-1
NON_EXFSIZEPBSTDEBT
CAPEX
CASH
DIV
NON_EX*CAPEXRISK = RISK1
0.252***
0.241***(3.89)(3.89)
0.00566*
0.00916**(1.79)(2.46)-0.00271***-0.00261***(-3.94)(-3.79)0.000305-0.000234(0.25)(-0.17)-0.00964***-0.00996***(-2.67)(-3.06)0.00679**
0.0320**(2.33)(2.04)-0.00676-0.00580(-1.05)(-0.87)-0.0425**-0.0481***(-2.46)(-2.78)-0.0401*(-1.67)

Constant
Year Dummies

Yes

Yes

RISK = RISK2
0.232***
0.219***(4.12)(4.04)
0.00669**
0.00952***(2.06)(2.75)-0.00281***-0.00263***(-3.76)(-3.47)0.000483-0.000108(0.44)(-0.09)-0.00820**-0.00893**(-2.13)(-2.54)0.00548*0.0328**(1.85)(2.33)-0.00842-0.00835(-1.17)(-1.33)-0.0424**-0.0444***(-2.47)(-2.71)-0.0443*(-1.95)0.0595***(5.02)Yes
Yes

Observations
1219
1219
1219
1219
Wald X2-statistics
648.49***641.62***
7.62***
457.62***
AR(1)
0.000
0.000
0.000
0.000
AR(2)
0.258
0.200
0.269
0.196
Hansen Test
0.162
0.174
0.182
0.226
No of instruments
127
127
127
127
Note: This table reports the two-step GMM system estimators with robust adjustment for a small sample.
Variables are defined the same as in Table 2.2. AR(1) and AR(2) are tests for first-order and second-orderserial correlation in the first-differenced residuals under the null of no serial correlation. Hansen test ofover-identification is under the null that all instruments are valid. The instruments are the lags of the
explanatory variables, and year dummies are treated as strictly exogenous variables. Statistically significant
at 1% (***), 5%(**), and 10%(*), respectively.

Although the fixed effects method is quite common for panel data, the estimatedresults may be inconsistent in case of potential endogenous problems. To prevent the bias
in coefficient estimates in Table 2.4, the paper re-estimates the models by dynamic
generalized method of moments (GMM) panel estimation technique proposed by22

Blundell & Bond (1998) and Roodman (2009). It allows treating all the explanatory
variables as endogenous variables (Roodman, 2009). Using a list of proper instrumental
variables, the application of dynamic GMM helps to solve the endogenous problems
which arise from simultaneity and unobservable heterogeneity. Besides, dynamic GMM
is preferred to eliminate the bias from ignoring dynamic endogeneity. Following Wintoki
et al. (2012), the estimated coefficients may still be biased if the current explanatory
variables are not completely independent of the lagged dependent variable. Because it isdifficult to identify exogenous instruments, dynamic endogeneity is usually ignored inmany previous studies.
By using the same instrument variables for all GMM models on the purpose ofcomparison, the interpretation of the significant coefficients on NON_EX and interaction
term in Table 2.7 remains the same as in Table 2.4. Regarding the moderating effect of
capital expenditure, the coefficients on the interaction term remain negatively significant
for all the columns, reinforcing the results in Table 2.4. Moreover, the robustness of themodel estimators is confirmed by the specification tests for system GMM. As expected,
the Hansen test indicates that the instruments used in the GMM estimations are notcorrelated with the error terms. Although there is evidence for negative first-order serial
correlation, second-order serial correlation is absent. Wintoki et al. (2012) argue that
serial correlation might exist in the first differences AR(1), but there should be no serial
correlation in the second differences AR(2). All further support the conclusion that the
instruments are used reasonably and the above GMM model is consistent.
2.5 Conclusion
After controlling for the problem of heteroskedasticity, autocorrelation, and potential
endogeneity by applying fixed effects with clustered robust standard errors and dynamic
GMM for a sample of 151 companies listed on Vietnamese stock markets in the period
2007-2016, this paper shows the positive impact of non-executive director ratio on firmrisk. It demonstrates that the inclusion of more non-executive directors does not benefit
the monitoring function. However, the risk management role of non-executive directors
is improved in the case of overinvestment. This finding is achieved by investigating themoderating role of capital expenditure as well as the difference in the impact of nonexecutive director ratio on firm risk in case of overinvestment and underinvestment. It
suggests that the presence of non-executive directors in firms with more capital
expenditures are likely to mitigate the volatility of stock returns. In other words, firms
23with high capital expenditures tend to urge non-executive directors to increasesupervision as well as to provide more links to external resources for minimizing risks.
From an application standpoint, the results should recommend that the listed firms
take stock return volatility into consideration before they intend to nominate and appoint
non-executive directors into their board, especially in overinvesting firms. From anotherperspective, adjusting board independence can play a significant role in pursuing a stableor risky business strategy.
By using alternative measures of overinvestment and firm risk, the findings are robust
enough to highlight the importance of adjusting an appropriate proportion of nonexecutive directors in managing risks in Vietnam boardrooms, especially from a capital
expenditure perspective. It also helps Vietnamese lawmakers understand more corporate
governance practices thoroughly and then improve current legislation.

24

CHAPTER 3: (PAPER 2) THE CHANGE IN BOARD INDEPENDENCE
IN THE PRESENCE OF FIRM RISK AND REGULATION
3.1. Introduction
Corporate governance has received the attention of researchers over the past several
decades, especially as the financial problems of companies appear due to the lack ofmonitoring. Severe shortcomings related to board independence, risk management,
executive remuneration in corporate governance code and principles led to the collapseof many financial institutions and then triggering the crisis (OECD, 2009). For instance,
the Asian crisis of 1997-1998 and the global financial crisis of 2007–2009 came fromweakness in corporate governance mechanisms (Cheah & Lee, 2009; Akbar et al., 2017),
partially due to the unclear separation of control and management. It is the motivation topromote the development of a suitable independent board to prevent such scandals in the
future. While a large number of research papers have focused on the effect of board
independence on firm risk, the opposite perspective has received relatively little attention.
Therefore, two primary factors motivate the research question:
Firstly, so far, there has been debate over the effects of firm risk on board
independence. According to many previous studies supported by the agency theory, thepresence of non-executive directors can reduce risks for companies. Based on thisargument, the organizational portfolio theory introduced by Donaldson (2000) suggeststhat in the case of high-risk periods, companies have many incentives to increase thenumber of non-executive directors on boards to prevent an unexpected low performance.
High-risk companies often encounter agency conflicts and therefore need more board
monitoring (Bathala & Rao, 1995). In contrast, Prendergast (2000) argues that in
uncertain environments, increased monitoring is not appropriate because of the highinformation cost. It means that companies with high stock return volatility often face theproblem of information asymmetry, so it is costly to transfer specific information tooutsiders (Raheja, 2005). Thus, it is difficult to make a reasonable assessment of the
impacts of firm risk on a non-executive ratio.
Besides, compared with developed economies, the monitoring role of non-executive
directors in Vietnamese listed companies as well as in other Southeast Asian companies
may be different in terms of market characteristics, economic instability, the strength of
institutions, government regulations, and so forth. For instance, non-executive directors
in these countries are usually appointed by majority shareholders who have a strong tie
25

with the management team. They are often perceived as a “rubber stamp” and areappointed for reasons other than monitoring (Haniffa & Cooke, 2002). For this reason,
the results of the studies on corporate governance from developed markets might not beappropriate in developing markets. It is a great motivation for this paper to investigate
whether firm risk drives demand for non-executive directors in Vietnamese companies.
Secondly, maintaining an independent board has become a major regulatory trend in
corporate governance and forced many firms to change their board structure to comply,
especially for high-risk firms. Governments have had significant interests in corporate
governance to prevent the collapse of financial markets from a lack of transparency anddisclosure in companies. For instance, in America, the Sarbanes-Oxley Act (2002) andthe Dodd-Frank Act (2010) forced companies to appoint more independent directors anddisclose more information about compensation. The Malaysian Code on Corporate
Governance formed promptly after the 1997-1998 Asian Crisis imposed the requirementon the appointment of more non-executive directors. In Vietnam, the Circular
121/2012/TT-BTC dated July 26, 2012, provided further regulations on corporate
governance applicable to public companies. This is the first legal document to define theconcept of non-executive directors in Vietnam. Therefore, this paper would like toinvestigate whether high-risk companies increase their board independence under thepressure of this regulation. In other words, whether has the enactment of this regulation
helped high-risk firms to become better aware of the monitoring role of non-executive
directors?
With a sample of 151 companies listed on the Vietnamese stock markets from 2007
to 2016, the primary purpose of this paper is to estimate the impact of firm risk on the
proportion of non-executive directors. This relationship is further explored in the presenceof regulation. The research results have two significant contributions. Firstly, itdemonstrates the U-shaped nonlinear impact of firm risk on the non-executive director
ratio. Listed companies in Vietnamese stock markets tend to decrease the proportion of
non-executive directors when their risk increases or, in other words, the correlation, in
this case, is negative because of the high cost of monitoring. However, the relationshipbecomes positive when firm risk is beyond a certain critical level because the companies
would like to prevent unexpected low performance caused by too high risk. Secondly, thepaper finds out that the Circular 121/2012/TT-BTC has had an impact on motivatingcompanies to increase the percentage of non-executive directors, especially for high-risk
firms.
26

The following section discusses the literature and develops hypotheses. The data andmethodology are explained in Section 4.3. Section 4.4 presents the results of the empiricalanalysis. Section 4.5 concludes the research.
3.2 Literature review and research hypotheses
3.2.1 The risk management role of non-executive directors
A board of directors is described by agency theorists as the "internal control"(Fernández & Arrondo, 2005) to solve the conflicts between owners and managers inorganizations (Hennessey, 2008; Fama & Jensen, 1983). The monitoring function of aboard relates to selecting senior executives (especially the chief executive officer – CEO),evaluating and rewarding their performance, protecting shareholders’ interests (Brickley& James, 1987). While the supervising activeness of a board is assessed by the frequency
of official meetings each year (Jackling and Johl, 2009; Azim, 2012), any changes inboard composition, such as gender (Hillman et al., 2007; Gul et al., 2011) or board
independence (Brick et al., 2012; Chen et al., 2016; Tong & Zhang, 2014), can also affectthe board monitoring performance. Indeed, many studies have typically considered thenumber of non-executive directors on board as one of the essential risk-control
mechanisms. Nevertheless, there have still been two competing views on the effect of
non-executive directors’ presence on risk management.
To support the presence of non-executive directors on boards, agency theory andresource dependence theory complement each other. Firstly, Jensen & Meckling (1976)
and Florackis (2008) suggest that agency conflicts can be controlled and minimized byincreasing the number of non-executive directors on board. The presence of nonexecutive directors is expected to be effective in monitoring as they are independent ofmanagement (Luan & Tang, 2007). Even firms with boards dominated by outside
directors are more likely to fire poorly performing CEOs (Brick et al., 2012; Weisbach,1988). Under the reputation hypothesis, non-executive directors would support
investments in less risky projects or pursue the risk-reducing strategies of corporate
diversification (Tong & Zhang, 2014) which will help firms avoid losses and thus protect
the image of their firms (Pathan, 2009) as well as protect their own reputation in the labormarket (Carcello et al., 2002). Secondly, increasing the presence of non-executive
directors can also be explained under resource dependence theory that they can serve tocoordinate organizational action, and provide external links to reduce risk (Singh, 2007).
An empirical study by Rosenstein & Wyatt (1990) proves that the appointment of outside27

directors leads to significantly positive excess returns. Uzun et al. (2004) also find thatthe incidence of corporate fraud decreases as the number of outside directors on board
increases.
In contrast, non-executive directors may not be aware of all the risks that are being
taken by executives. It is because non-executive directors typically do not engage in the
day-to-day management of the organization. Additionally, non-executive directors do nothave enough specific knowledge and experience regarding processes such as sector
analysis, internal benchmarks, guidelines, and so forth, while executive directors are an
essential source of firm-specific information for the board (Raheja, 2005).
Besides, the concentrated ownership and weak legal protection in Asian countries
partly weaken the role of non-executive directors. In Vietnam, a listed company may becontrolled by a single shareholder or a group of shareholders who own a large proportionof shares. They are well informed about the operation of the company and able to closely
oversee the management. There is too much overlap between management and directors.
As a result, non-executive directors can hardly perform their duties adequately because
they are usually proposed by majority shareholders, so they gradually play the role ofadvisors other than supervisors.
3.2.2 The impacts of firm risk on non-executive director ratio
Based on the above arguments about the risk management role of non-executive
directors, firm risk is likely to have two different impacts on the number of non-executive
director positions on a board.
High-risk companies will have more incentives to increase the number of nonexecutive directors. Donaldson (2000) develop organizational portfolio theory to support
this viewpoint. High risk is derived not only from internal factors (undiversification,
undivisionalization, high leverage, and so on) but also from external factors (financial
market downturn, business cycle change, and increasing competitors) that make acompany’s performance drop below the expected level. As a result, the board members
are criticized for failing to protect the shareholders, and corporate governance becomes asevere problem. With a low and unacceptable performance, a typical board is independentof management: It means that the companies will tend to increase the number of nonexecutive directors or replace executives with non-executive directors (Hermalin &Weisbach, 1988). This is consistent with the argument of Pearce & Zahra (1992) that as
firms compete in an uncertain environment, the representation of outside directors
28

increases. Graham & Narasimhan (2004) also find out that companies with boards
dominated by insiders are less likely to survive the depression. Because non-executive
directors usually have different skills and backgrounds that help a company to pursue
opportunities in a new market or industry, so they can play a linking role that connects acompany to external resources (Chen et al., 2016). Bathala & Rao (1995) also state thathigh-risk companies often encounter agency conflicts and therefore need more board
monitoring. This point of view is supported by Birnhaum (1984), who reported that thelack of information and volatility might cause increased board size and outsiders’representation.
However, the negative impact of risk firm on the non-executive ratio is taken into
more consideration. Prendergast (2000) states that monitoring is less desirable inuncertain environments because of information costs. Fama & Jensen (1983) also notethat firms with high stock return volatility are more likely to have specific information
unknown to outsiders. Consequently, firms with higher information asymmetry can havehigher verification costs (Raheja, 2005). When verification costs are high, there are fewer
incentives for the separation between management and ownership. As Maug (1997)shows, it is not optimal for firms with high information asymmetry to invite monitoringfrom independent directors because it is costly for firms to transfer firm-specificinformation to outsiders. In line with this viewpoint, Kim et al. (2014) also state thatoutside directors face higher costs to accumulate knowledge about the firm while insidedirectors may be better monitors thanks to the superior amount and quality of information
they have about the operations of the firm. Consequently, Adams & Ferreira (2007) and
Raheja (2005) generally suggest that the number of outsiders decreases in the cost ofmonitoring.
Even so, the two above impacts are not entirely contrary to each other because
Demsetz & Lehn (1985) and Linck et al. (2008) state that the optimal level of monitoringis determined by the tradeoff between the costs and benefits of monitoring. Therefore,
companies are motivated to increase the percentage of non-executive directors when firmrisk is too low or too high. In case that risk is too low, companies may increase their nonexecutive director ratio because of the low cost of information. On the contrary,companies that have too high risk may need more monitoring to ensure that theirperformance is not below the expectation level in the future. Hence, this research also
expects a nonlinear relationship between firm risk and non-executive director ratio.
H1: Firm risk has a nonlinear impact on the proportion of non-executive directors
29

3.2.3 The moderating effect of regulation
Regulations might be considered as an additional external force to board
independence (Hermalin & Weisbach, 2006; Romano, 2005). Shifts in the regulations
motivate significant changes in board composition and leadership structure (Hillman,
Cannella & Paetzold, 2000). Agrawal & Knoeber (1996) state that outsiders are
sometimes added to boards for political reasons. Linck et al. (2006) document theadditional monitoring costs imposed upon firms as a result of new regulations. For
instance, in the United States, the Sarbanes-Oxley Act (2002) and the Dodd-Frank act(2010) forced companies to appoint more independent directors and disclose more
information about compensation. In the context of the United Kingdom, the codes of bestpractice adopted, beginning with the Cadbury Report in 1992, provide a set ofrecommendations for the board’s composition and responsibilities. The Cadbury Report(1992) required that at least three non-executives be on board; the Hampel Report (1998)
also required that at least one-third of the board be non-executives, and the Higgs Report(2003) required at least 50%. Consequently, the London Stock Exchange witnessed a
steady increase in the number of outside directors and their average shareholding ratio.
Moreover, regulations create pressures to force high-risk firms to alter their behavior
to comply and to avoid potential costly stockholder litigation (Trueman, 1997). The
research by Boyd (1995) shows that uncertainty, level of competition, and regulation
affect board size, outsider ratio, and interlocks. Specifically, the Malaysian Code on
Corporate Governance formed promptly after 1997-1998 Asian Crisis and the revised
Malaysian Code on Corporate Governance (2007) required that non-executive directors
should represent one-third of total board members (Cheah & Lee, 2009), which imposed
the requirement on the appointment of more non-executive directors. As a result, Shakir(2012) found that the board composition was made up about 63.4% of non-executive
directors by using 81 property sector companies listed on the Kuala Lumpur Stock
Exchange (KLSE) for the period 1999 to 2005. Brick & Chidambaran (2008) also
conclude that regulations have two effects on the level of board monitoring. First, thelevel of board independence will increase in response to the regulations. Second, theincrease in the non-executive ratio is likely to be higher in high-risk firms.

30

3.2.4 Regulations about non-executive directors in Vietnam.
International practices distinguish different categories of directors according to levelsof responsibility, segregation of control and policy development, and often divide theminto three categories: executive, non-executive, and independent directors. In Vietnam,
there was no clear distinction for three categories of directors in the law on enterprises
before 2012. They were only mentioned very ambiguously in Decision 15 of the Ministryof Finance dated March 19, 2007, on the model charter applicable to listed companies on
the stock exchange and in Decision 12 of the Ministry of Finance dated March 13, 2007
providing regulations on corporate governance applicable to listed companies. Both ofthem only classified directors into two categories: (i) executive directors, and (ii) nonexecutive and independent directors but provided no specific definition of the term “nonexecutive and independent directors”.
Figure 3.1: One-tier and two-tier board structure
Board Structure

Two-tier Board Model

One-tier Board Model

The Supervisory Board
In charge ofdecision control

Board of directors
In charge ofdecision control anddecision management

The Management Board
In charge ofdecision management

Source: Maassen, G. F. (1999).
Until 2012, the Circular 121/2012/TT-BTC issued on July 26, 2012, provided further
regulations on corporate governance applicable to public companies, in which theconcepts of “non-executive directors” and “independent directors” were presented quite
clearly. A non-executive director must be a member of the supervisory board and not be
a general manager, deputy general manager, chief accountant, or any other managers
appointed by the supervisory board. It is noted that the board structure for Vietnameselisted companies is categorized as two tiers including a management board (the lowertier) which is responsible for firms’ operation and a separate supervisory board (the uppertier) which assumes supervisory functions as to the management and operation of thecompany (Belot et al., 2014). In a two-tier board system, the supervisory board is led by31

a chairman while the top leader of the executive management board is a CEO. Such adual board structure is popular in Germanic countries of continental Europe, such as
Germany and the Netherland while The United States and the United Kingdom provide
examples of unitary board structure which gathers both managing board and supervisoryboard in one group (Douma, 1997).
Basically, the Circular 121/2012/TT-BTC has promoted the change in the supervisoryboard structure of listed firms to create credibility for the market (Nguyen & Phan, 2016).
This regulation required that the number of supervisory board members shall be fromthree to eleven, and at least one third (1/3) of the supervisory board must be the nonexecutive director for listed companies. It caused a challenge to some publicly listed firms
which had not met the minimum requirement of the non-executive director ratio (Vu etal., 2017). Furthermore, clearly defining the position and responsibility of the nonexecutive director in this regulation made an essential contribution to ensuring corporate
accountability and protecting the legitimate interests of shareholders and investors(Roberts et al., 2005; Daily, Dalton & Cannella, 2003). As a result, the non-executive
ratio becomes one of the criteria for investors to monitor and evaluate the supervisoryboard 's transparency and reliability (Chang et al., 2006). Hence, companies tend toincrease this ratio properly to bring confidence to investors, lenders, and shareholders,
especially for high-risk companies.
H2: Regulation plays as a moderating factor in the relationship between firm risk andthe percentage of non-executive directors
3.3 Data, variables, and methodology
3.3.1 Research data
Data for this paper are collected by reviewing annual reports of 151 non-financial
companies listed on Vietnamese stock markets from 2007-2016. The year 2007 is chosen
as the starting year because Vietnamese Securities Law, which prescribes additional rules
for listing stocks, transparency and the disclosure of information by public companies,
was issued in June 2006 and took effect on January 1, 2007. However, this paper also
needs to know the change in the supervisory boards between the current year and theprevious year; therefore, financial reports in 2006 are essential. They are available on theofficial websites of the two Vietnamese stock exchanges, HOSE (Ho Chi Minh City Stock
Exchange) and HNX (Hanoi Stock Exchange). The total numbers of listed financial and32

nonfinancial companies on two securities trading center HNX and HOSE in 2006 are 87
and 106, respectively. Hence, the selected sample is highly representative.
Following the ICB Industry Classification Benchmark, these companies are from nineof the ten industry groups except the telecommunication industry. The financial
companies such as banks, insurance, and financial services are excluded from the sample
because they act as market makers, and more specifically, the board structure of thesecompanies must comply with some regulations from the state bank. As shown in Figure
3.2, industrials and consumer goods account for significant proportions in the sample.
Figure 3.2. Industry distribution
54

38
12
1

6

12

8

14
6

Source: Research data
3.3.2 Measurement of variables
Dependent variable
Because listed firms in Vietnamese stock markets apply a two-tier board system,
the proportion of non-executive directors (NON_EX) in this research is measured as thenumber of non-executive directors to total supervisory board members ratio. The
calculation helps to evaluate the change in the percentage of non-executive directors more
appropriately in the absence of management board members. It is different from the nonexecutive director measure used in most of the previous papers such as Florackis & Ozkan(2009), De Andres & Vallelado (2008) which concentrate on investigating one-tier boards(the number of non-executive directors is therein divided by the total members in a onetier board).
In addition, non-executive directors in the sample need to retain their seats formore than six months in a fiscal year to ensure that their involvement can have an impact
on the performance. This approach helps to determine more exactly whether firm risk
drives companies to change their supervisory board structures.
33

Independent variables
To investigate the impacts of firm risk on the non-executive ratio, the researchuses two proxies for risk measurement. Firstly, RISK1 equals the standard deviation ofdaily stock return for two years preceding the end of the fiscal year. Secondly, RISK2
equals the standard deviation of the residuals from the model:  ୧୲ =Ƚ୧ +Ⱦ୧ ୲ + ɂ୧୲ for
two years preceding the end of the fiscal year (where,  ୧୲ donates the daily stock return;୲ represents the daily market return based on the VN-index; the ɂ୧୲ stands for the
residuals). The two risk measures are used much in the previous studies related to the link
between governance structure and firm risk (Cheng, 2008; Nakano & Nguyen, 2012;
Wang, 2012; Brick & Chidambaran, 2008).
The squared value of firm risk (RISK_SQ) is used to capture the nonlinear effectof firm risk on the proportion of non-executive directors. RISK_REG is an interaction
variable between firm risk and regulation (RISK*REG). REG is a dummy variable for
the Circular 121/2012/TT-BTC (REG equals 1 for the post-2012 period, and 0 otherwise).
Control variables
The research uses several control variables, including board size (BSIZE), firm
size (FSIZE), debt maturity (STDEBT), dividend payout ratio (DIV), and replacement
director ratio (REPLACE).
BSIZE and FSIZE are the natural logarithm of the total number of supervisoryboard members and total assets, respectively. Denis & Sarin (1999) and Weisbach (1988)
also suggest that board composition may be related to board size and firm size.
STDEBT is current liabilities over the sum of current liabilities and long-term debt
(Demirguc-Kunt & Maksimovic, 1999). It serves as short-term debt is a “powerful tool
to monitor managers” (Stulz, 2000) and facilitates creditors to monitor managers withminimum efforts (Rajan & Winton, 1995). Burkart et al. (2003) argue that short-term debt
can be used as a mechanism to mitigate any potential agency conflicts in weak investor
protection countries. On the other hand, monitoring by debtholders could substitute forboard monitoring, which would imply a negative coefficient.
DIV is the ratio of dividend payments to total assets. Easterbrook (1984) proposesthat dividend reduces the agency cost of free cash flow and minimize suboptimal
managerial behavior. Dividend payout is considered as an outcome of strong corporate
governance in emerging markets (Mitton, 2004). Therefore, companies that have a history34

of high dividend payments are less likely to require more control from non-executive
directors.
REPLACE is calculated as the number of replacement directors (the new directors
replace another board members) to the total number of board members. It is noted that anadditional appointment to expand board size is not considered as a replacement in thispaper because an increase in the number of directors through additional appointments is
captured by BSIZE variable. Following Rosenstein & Wyatt (1990) that replacement
announcements are ‘‘noisier’’ than board expansion announcements, using REPLACE
variable is necessary to investigate the impact of board structure reform on the nonexecutive ratio. According to Baysinger & Butler (1985), corporate board reform efforts
generally result in the growth of outside directors’ representation to solve an agency
problem between shareholders and managers.
3.3.3 Method of testing research hypotheses
Following Brick & Chidambaran (2008), this paper includes both RISK_SQ and
RISK_REG into the model to test these two above hypotheses simultaneously.
Additionally, all right-side control variables are used with a one-year lag to establish thedirection of causality (Brammer & Pavelin, 2008). Analytically, the regression modelwith nonlinear and moderating effects on board independence is shown by equation (3.1).
An F-test of joint significance for all independent variables is also significant.
NON _E X i t = Ⱦ଴ + Ⱦଵ R IS K i t + Ⱦଶ R IS K_ S Q i t + Ⱦଷ R E G i t + Ⱦସ R IS K _R E G i t+Ⱦହ REPLACEit-1 + Ⱦ଺ BSIZEit-1 + Ⱦ଻ FSIZEit-1 + Ⱦ଼ STDEBTit-1 +Ⱦଽ DIVit-1 + ɂit(3.1)

Although the common econometric methodologies employed for panel data are
fixed effects (FE) and random effects (RE) with firm-level clustered standard errors, fixed
and random effect estimators may be biased and inconsistent in case of potential
endogenous problems. Most empirical corporate finance researchers acknowledge that
there are three types of endogeneity: unobservable heterogeneity, simultaneity, anddynamic endogeneity.
Firstly, simultaneity might exist in the relationship between non-executive
director ratio and firm risk. As mentioned above, high return volatility in a period maylead to a change in the non-executive ratio in that period while the reverse can also be
accepted – the non-executive ratio has an impact on firm risk. In this case, the nonexecutive ratio and firm risk are simultaneously determined.
35

The second endogeneity – unobservable heterogeneity - stems from omitted
variables that can affect both the proportion of non-executive directors and the
explanatory variables such as the managerial ability. Hermalin & Weisbach (1998)
suggest that firms with many high-ability managers require fewer outsider directors
because those managers can have enough skills and knowledge to control risks better.
Finally, dynamic endogeneity is usually ignored due to the difficulty in identifying
exogenous instruments. This endogeneity arises from the possibility that the current firmrisk and some explanatory variables are affected by the past non-executive ratio. Althoughunobservable heterogeneity can be eliminated by the application of fixed effects models,
the reported coefficient estimates may still be biased if the current values of explanatory
variables are not entirely independent of the lagged dependent variable (Wintoki et al.,2012).
Consequently, this paper will re-estimate the impacts of firm risk on board
independence in a dynamic framework. It means that the lags of the dependent variable
are included to capture the dynamic effect of past board independence (Nguyen et al.,2014). Following Akbar et al. (2017) and Wintoki et al. (2012), the study estimates an
OLS regression of NON_EXit on NON_EXit-1, NON_EXit-2, NON_EXit-3, controlling forother firm characteristics, to determinate how many lags should be included. The study
finds no effect of NON_EXit-2 on NON_EXit, which means including the one-year lagged
dependent variable to be enough to capture the past effect of board independence. Zhou
et al. (2014) also suggest that a first-order autoregressive structure is more commonlyused in empirical corporate finance studies due to the limited length of the time dimension
in panel data. Therefore, the model is rewritten as follows:
NON_EXit = Ⱦ଴ + ȾଵNON_EXit-1 + Ⱦଶ RISKit + Ⱦଷ RISK_SQit + Ⱦସ REGit +Ⱦହ RISK_REGit +Ⱦ଺ REPLACEit-1 + Ⱦ଻ BSIZEit-1 + Ⱦ଼ FSIZEit-1 +Ⱦଽ STDEBTit-1+Ⱦଵ଴DIVit-1 + ɂit(3.2)

The model is estimated by the system GMM estimator proposed by Blundell andBond (1998) and Roodman (2009). This method relies on the lags of dependent andexplanatory variables which are used as instruments. Using a list of proper instrumental
variables, the application of dynamic GMM also helps to remove heteroskedasticity,
multicollinearity and serial autocorrelation problem in the model (Ruhashyankiko &Yehoue, 2006).

36

3.4. Results and discussion
3.4.1 Description statistics and correlation matrix
Descriptive statistics of the research variables are presented in Table 3.1. The
average total risk (idiosyncratic risk) in Vietnamese companies is 0.032 (0.029). The
average proportion of non-executive directors is around 63.1%. From 2008 to 2012, thenon-executive director ratio was maintained at around 61.6% with relatively slow growth
while the average level of firm risk is quite high. During the later period of the research,
Figure 3.3 shows that there is an apparent increase in the proportion of non-executive
directors (from below 63% to 67%), and firm risk remains slightly lower. The diagram
creates an expectation of a negative correlation between these two variables.
Table 3.1: Description statistics
Variable

Obs

Mean

Std. Dev.

Min

Max

RISK1

1306

0.032

0.008

0.003

0.074

RISK2

1306

0.029

0.008

0.012

0.074

NON_EX

1510

0.631

0.178

0.143

1.000

REPLACE

1510

0.116

0.186

0.000

1.000

BSIZE

1510

1.706

0.191

1.099

2.565

FSIZE

1510

13.215

1.340

9.734

17.319STDEBT

1510

0.829

0.222

0.074

1.000

DIV

1510

0.033

0.044

0.000

0.359

Notes: The table presents descriptive statistics among the variables of this study, where RISK1 is total risk,
RISK2 is idiosyncratic risk, NON_EX is non-executive director ratio, REPLACE is replacement director
ratio, BSIZE is board size, FSIZE is firm size, STDEBT is short-term debt maturity, DIV is dividend payout
ratio.

Figure 3.3: The mean of firm risk and non-executive director ratio by year
from 2008 to 2016
0.040

68.60%

0.035

67.20%

0.030

65.80%

0.025

64.40%

0.020

63.00%

0.015

61.60%

0.010

60.20%

0.005

58.80%

0.000

57.40%
2008

2009

2010

2011
RISK1

2012
RISK2

2013

2014
NON_EX

Source: Research data
37

2015

2016

Table 3.2: Correlation matrix
NON_EX

RISK1

RISK1_SQRISK1_REG

REPLACE

BSIZE

FSIZE

STDEBT

RISK1-0.073

RISK1_SQ-0.061

0.981

RISK1_REG

0.114-0.006

0.011

REPLACE

0.152-0.012-0.008

0.094

BSIZE

0.174

-0.172-0.165-0.053-0.133

FSIZE

0.119

-0.383-0.364

0.016

0.000

0.317

STDEBT-0.010-0.019-0.015-0.009-0.002-0.141-0.330DIV

0.049-0.176-0.147-0.117-0.0400.011-0.0980.185

NON_EXRISK2

RISK2_SQRISK2_REG

REPLACE

BSIZE

FSIZE

STDEBT

RISK2-0.046

RISK2_SQ-0.026

0.980

RISK2_REG

0.112

0.215

0.225

REPLACE

0.152

0.007

0.012

0.097

BSIZE

0.174

-0.218-0.197-0.063-0.133

FSIZE

0.119

-0.470-0.426-0.008

0.000

0.317

STDEBT-0.010

0.055

0.046

0.001

-0.002-0.141-0.330DIV

0.049-0.168-0.139-0.117-0.0400.011-0.0980.185

Notes: The table presents the correlation matrix among the variables of this study, where RISK1 is totalrisk, RISK2 is idiosyncratic risk, RISK1_SQ is the squared value of total risk, RISK2_SQ is the squared
value of idiosyncratic risk, RISK1_REG is the interaction term of total risk and regulation, RISK2_REG is
the interaction term of idiosyncratic risk and regulation, NON_EX is the proportion of non-executive
directors, REPLACE is replacement director ratio, BSIZE is board size, FSIZE is firm size, STDEBT isshort-term debt maturity, DIV is dividend payout ratio.

Table 3.2 presents the correlation matrix among the variable of this research. The
correlations between non-executive directors and firm risk, RISK1 and RISK2, are -0.073
and -0.046, respectively, while the negative relationships with the squared firm risk arelower (-0.061 and -0.026, respectively). It demonstrates the gradually improved
percentage of non-executive directors as companies face higher risks. Notably, thecorrelation between RISK1_REG/RISK2_REG and NON_EX is positive. The result
indicates that in the presence of regulation, the effect of risk on the proportion of nonexecutive directors may have been changed. According to Gujarati (2003), if thecorrelation coefficients are 0.8 or higher, the model is at risk of violating multicollinearity.
As evident in Table 3.2, the high values (0.981 and 0.980) between RISK and RISK_SQ
show the potential collinearity problem. However, this problem is so common when there
is an interaction term between 2 variables or other higher-order terms such as the squareof a variable. Additionally, Brambor et al. (2006) state that the omission of essential
variables is much more problematic than multicollinearity because omitted variable bias
causes the coefficients to be wrong. In this research, GMM is used to treat this problem,as mentioned above.
38

3.4.2 The impacts of firm risk and regulation
Table 3.3 and Table 3.4 show that there are not much statistically significant
differences in the impact of the explanatory variables on the independent variable,
regardless of the application of fixed effects or random effects.
Firstly, Table 3.3 and Table 3.4 display a hypothesized U-shaped relationship between
firm risk and non-executive director ratio. At first glance, most of the negative
coefficients on RISK1/RISK2 appear to be significant at 5% level in Table 3.3 and Table
3.4, which means that companies tend to reduce the non-executive director ratio whenfirm risk increases. In other words, the proportion of non-executive directors has not beenassessed as an essential factor in controlling risk as well as helping firms improve theirperformance due to high monitoring costs (Adams & Ferreira, 2007; Raheja, 2005). This
result is in contrast to Guest (2008), who found a positive effect of stock return volatility
on board independence by using a large sample of UK firms from 1981 to 2002. It isbecause the monitoring role of outside directors is more highly appreciated in developed
countries. Meanwhile, the previous research by Van Tuan & Tuan (2016) concludes thatthe presence of non-executive directors has a significantly negative influence on thefinancial performance of Vietnamese companies. As stated above, non-executive
directors are not regularly involved in the day-to-day running of the business, so they
have low insights into different aspects of the business. It hinders them from performing
their oversight activities and assess risks effectively. More remarkably, the appointmentof non-executive directors in Vietnamese companies are usually driven by friend or
family relationship with majority shareholders rather than by expertise and experience.
As a result, they do not have many incentives to monitor, or they are not likely to oversee
management activities because of being not qualified professionals. In this case, theirpresence on board may increase the conflicts between majority shareholders and minority
shareholders, so leading to the devaluation of companies by investors.
However, the risk management role of non-executive directors is not entirely denied
because the coefficients on the squared firm risks are significantly positive, indicatingthat the need for non-executive directors starts to increase again when firm risk reacheda certain critical level. It is because firms tend to require more separation between
ownership and management, especially when more severe agency problems arise between
controlling and non-controlling shareholders, with a view to improving firm performanceand regaining investors’ confidence. This result can also be explained under the resource
dependence theory that the increased presence of non-executive directors provides access39

to external resources to mitigate risk. Generally, the effects of RISK and RISK_SQ on
NON_EX confirm a nonlinear relationship between firm risk and non-executive director
ratio. The findings are supported by the argument of Demsetz & Lehn (1985) and Linck
et al. (2008) that the optimal level of monitoring is determined by the tradeoff between
the costs and benefits of monitoring.
Secondly, by hierarchical analysis, the results also support the hypothesis that
regulation plays as a moderating factor in the relationship between firm risk and nonexecutive ratio. In column 2 and 5, all the coefficients on REG are significantly positive
at 1% level, indicating that the Circular 121 has an impact on board independence. This
result is once again different from Guest (2008), who do not support that therecommendations of Cadbury (1992) Hampel (1998) on board independence can change
UK firms’ board structure, because such regulations have been voluntary. On thecontrary, Chen & Al-Najjar (2012) indicate that requirements on independent directors
from the Chinese Security Regulation Commission have imposed pressure on Chinese
firms to increase board independence. However, the question of whether such regulation
will make a board more efficient should be considered with caution because adding more
non-executives to the board may be only a temporary response to the pressure of the
Circular. For instance, companies may randomly invite non-executive directors toparticipate on their boards to merely demonstrate that they comply strictly with the rule.
In that case, the presence of non-executive directors on the board may not necessarily
have a beneficial impact on the independence of the board (Van Tuan & Tuan, 2016;
Chen, & Al-Najjar, 2012). For this reason, the impact of the interaction between
regulation and firm risk on the non-executive ratio should be examined to evaluate theefficiency of the regulation. In columns 3 and 6, the interaction term
RISK1_REG/RISK2_REG is also significantly positive, but the coefficients on REG are
insignificantly negative. All the results show that REG is a pure moderator, indicatingthat the enactment of the Circular 121 has increased the proportion of non-executive
directors, especially for high-risk companies. It is consistent with the prior publishedstudy by Brick & Chidambaran (2008), which suggests that high-risk firms would be
pushed by regulations to increase board independence, and thereby intensify monitoringand supporting activities.
However, the signs of some control variables, such as STDEBT and DIV are not inline with expectations, which can be caused by unsolved endogenous problems.

40

Therefore, the two-step system GMM approach should be used to obtain more consistent
results.
Table 3.3: Fixed effects
Dependent
variable
NON_EX
RISK
RISK_SQRISK = RISK1 (Total risk)
(1)

(2)

(3)

(4)

(5)

-5.637**-3.622-5.555**-5.446**-4.913**-5.814**(-2.18)(-1.44)(-2.34)(-2.09)(-2.01)(-2.57)99.05**

76.30**

90.63***

107.9***

96.77***

96.33***(2.59)(2.12)(2.74)(2.79)(2.75)(2.98)

0.0357***-0.0300

0.0324***-0.0246(3.24)(-0.90)(3.04)(-0.77)REG
RISK_REGREPLACE(t-1)

RISK = RISK2 (Idiosyncratic risk)(6)2.087*

1.938*(1.84)(1.66)

0.0708***0.0646***

0.0644***0.0705***0.0649***0.0644***(4.25)(4.12)(4.13)(4.26)(4.16)(4.17)

0.0407***0.01970.01980.0387***0.01590.0173(3.22)(1.39)(1.39)(3.07)(1.11)(1.23)

0.04840.05220.05580.04840.0546

0.0563(1.41)(1.49)(1.58)(1.42)(1.55)(1.59)

0.0553**0.03780.04340.0556*

0.03690.0452(1.98)(1.33)(1.54)(1.97)(1.29)(1.59)

0.272**

0.285**

0.298**

0.292**

0.292**

0.297**(2.23)(2.41)(2.50)(2.39)(2.47)(2.51)

0.0245

0.254

0.290

0.0376

0.324

0.322

(0.13)(1.28)(1.42)(0.21)(1.65)(1.64)

Obs

1306

1306

1306

1306

1306

1306

F-statistic

7.26***

7.05***

7.23***

7.04***

7.05***

7.15***

R-sq within

0.05160.07250.07740.05530.07300.0776

R-sq between

0.02770.04040.04410.03240.05400.0528R-sq overall

0.03390.0521

0.05640.03940.05900.0610FSIZE(t-1)
BSIZE(t-1)
STDEBT(t-1)
DIV(t-1)
Constant

Notes: The table presents the results of the fixed effects estimator. RISK1 is total risk, RISK2 isidiosyncratic risk, RISK_SQ is the squared value of total risk/idiosyncratic risk, RISK_REG is theinteraction term of total risk/idiosyncratic risk and regulation, NON_EX is the proportion of non-executive
directors, REPLACE is replacement director ratio, BSIZE is board size, FSIZE is firm size, STDEBT isshort-term debt maturity, DIV is dividend payout ratio. Robust t-statistics adjusted for firm-level clustering
are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

41

Table 3.4: Random effects
Dependent
variable
NON_EX
RISK
RISK_SQRISK = RISK1 (Total risk)
(1)

(2)

(3)

(4)

(5)

(6)

-5.918**-3.534-5.554**-5.386**-4.766**-5.695**(-2.35)(-1.47)(-2.37)(-2.18)(-2.07)(-2.56)97.27***

72.07**

87.06***

105.1***

93.44***

93.13***(2.68)(2.13)(2.70)(2.92)(2.90)(2.97)

0.0371***-0.03170.0336***-0.0241(3.64)(-0.97)(3.42)(-0.76)REG
RISK_REGREPLACE(t-1)

RISK = RISK2 (Idiosyncratic risk)

2.182**

1.968*(1.98)(1.70)

0.0758***0.0686***

0.0682***0.0754***0.0688***0.0682***(4.56)(4.38)(4.39)(4.56)(4.41)(4.41)

0.0272***0.01450.01480.0281***0.01270.0138(2.97)(1.58)(1.61)(3.02)(1.38)(1.49)

0.0690**0.0748**0.0782**0.0680**0.0764**0.0777**(2.28)(2.45)(2.51)(2.26)(2.49)(2.52)

0.0533*0.03890.04420.0551**0.03850.0460*(1.92)(1.42)(1.62)(1.97)(1.39)(1.67)

0.268**

0.289**

0.302***

0.293**

0.295***

0.302***(2.32)(2.58)(2.66)(2.50)(2.63)(2.66)

0.163

0.274*

0.309**

0.128

0.314**

0.318**(1.09)(1.91)(2.09)(0.86)(2.17)(2.19)

Obs

1306

1306

1306

1306

1306

1306

Chi-sq148.34***148.08***163.13***147.59***151.83***166.54***R-sq within

0.04940.07180.07680.05350.07250.0771

R-sq between

0.05870.07810.0826

0.06380.08740.0889R-sq overall

0.05720.07760.0826

0.06250.08350.0866

FSIZE(t-1)
BSIZE(t-1)
STDEBT(t-1)
DIV(t-1)
Constant

Notes: The table presents the results of the random effects estimator. RISK1 is total risk, RISK2 isidiosyncratic risk, RISK_SQ is the squared value of total risk/idiosyncratic risk, RISK_REG is theinteraction term of total risk/idiosyncratic risk and regulation, NON_EX is the proportion of non-executive
directors, REPLACE is replacement director ratio, BSIZE is board size, FSIZE is firm size, STDEBT isshort-term debt maturity, DIV is dividend payout ratio. Robust t-statistics adjusted for firm-level clustering
are reported in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.
The industrial dummies are included but are not reported.

42

Table 3.5: Dynamic GMM results
RISK = RISK1 (Total risk)

Dependent variable

RISK = RISK2 (Idiosyncratic risk)

NON_EX

(1)

(2)

(3)

(4)

(5)

(6)

NON_EX(t-1)

0.748***

0.752***

0.715***

0.697***

0.700***

0.685***(8.48)(8.70)(7.85)(7.84)(8.29)(8.06)-7.176**-7.207**-8.296**-9.692**-9.749**-10.75***(-2.03)(-2.04)(-2.22)(-2.46)(-2.44)(-2.74)89.48*

90.07*

88.90*

132.1**

133.3**

126.9**(1.95)(1.96)(1.72)(2.31)(2.30)(2.22)

0.260*-0.0287

0.368**-0.0193(1.68)(-0.93)(2.40)(-0.64)RISK
RISK_SQREG
RISK_REGREPLACE(t-1)
FSIZE(t-1)
BSIZE(t-1)
STDEBT(t-1)
DIV(t-1)
Constant

1.778**

1.667*(2.06)(1.79)

0.03810.03710.0101

0.04640.04640.0150(0.66)(0.65)(0.22)(0.80)(0.80)(0.32)-0.0104-0.0102-0.0117-0.0160*-0.0160*-0.0161*(-1.09)(-1.06)(-1.11)(-1.81)(-1.80)(-1.72)0.129*

0.126*

0.132*

0.149*

0.146**

0.157**(1.73)(1.70)(1.72)(1.96)(2.00)(2.16)-0.0306-0.0318-0.0232-0.0324-0.0332-0.0102(-0.60)(-0.66)(-0.47)(-0.60)(-0.65)(-0.18)-0.0580-0.0569-0.0256-0.104-0.101-0.0788(-0.26)(-0.25)(-0.12)(-0.47)(-0.46)(-0.37)0.232

0.299*

0.334**

0.339**(1.52)(1.92)(2.12)(2.24)

Year dummies

Yes

Yes

Yes

Yes

Yes

Yes

Obs

1306

1306

1306

1306

1306

1306

Wald X2-statistics

17.06***

1772.76***

18.74***

11.71***

1636.46***

14.70***

AR (1)

0.000

0.000

0.000

0.000

0.000

0.000

AR (2)

0.462

0.463

0.518

0.497

0.498

0.556

Hansen test

0.351

0.344

0.428

0.512

0.502

0.493

No of instruments

105

106

108

105

106

108

This table reports the two-step GMM system estimators with robust adjustment for a small sample.
Explanatory variables: RISK1 is total risk, RISK2 is idiosyncratic risk, RISK_SQ is the squared value of
total risk/idiosyncratic risk, RISK_REG is the interaction term of total risk/idiosyncratic risk and regulation,
NON_EX is the proportion of non-executive directors, REPLACE is replacement director ratio, BSIZE isboard size, FSIZE is firm size, STDEBT is short-term debt maturity, DIV is dividend payout ratio. AR (1)and AR (2) are tests for first-order and second-order serial correlation in the first-differenced residuals
under the null of no serial correlation. Sargan/Hansen test of over-identification is under the null that all
instruments are valid. The instruments are the lags of the explanatory variables, and YEAR dummies aretreated as strictly exogenous variables. Statistically significant at 1%(***), 5%(**), and 10%(*),
respectively.

43

Table 3.6: Robustness checks with two alternative measures of firm risk
Dependent variable

RISK = RISK3RISK = RISK4NON_EX

(1)

(3)

(4)

NON_EX(t-1)
RISK
RISK_SQ
REG

0.768***

0.757***

0.767***

0.758***(8.21)(7.92)(8.08)(7.90)-0.984*-1.536**-0.371*-0.596**(-1.81)(-2.39)(-1.75)(-2.36)

3.209**

1.717*

0.486**

0.257*(2.12)(1.77)(2.04)(1.78)

0.394**-0.0279

0.381**

0.266**(2.58)(-1.08)(2.52)(2.18)

RISK_REGREPLACE(t-1)
FSIZE(t-1)
BSIZE(t-1)
STDEBT(t-1)
DIV(t-1)(2)

1.108*

0.439*(1.82)(1.85)

0.02300.01580.02900.0186(0.53)(0.34)(0.65)(0.40)-0.000261

0.004290.000459

0.00493(-0.03)(0.57)(0.06)(0.68)-0.0778-0.0772-0.0797-0.0743(-1.08)(-1.08)(-1.16)(-1.07)-0.0915*-0.0473-0.0856*-0.0422(-1.82)(-0.99)(-1.68)(-0.89)0.129

0.07140.106

0.0790(0.59)(0.37)(0.52)(0.43)

Constant

0.319**(2.54)

Year Dummies

Yes

Yes

Yes

Yes

Obs

906

906

906

906

Wald X2-statistics

1589.94***

8.22***

1623.38***

1886.02***

AR (1)

0.000

0.000

0.000

0.000

AR (2)

0.146

0.112

0.151

0.112

Hansen test

0.165

0.349

0.145

0.392

No of instruments

104

108

104

108

This table reports the two-step GMM system estimators with robust adjustment for a small sample.
Explanatory variables: RISK3 is the volatility of a firm ‘s return on assets (ROA) over five-year overlapping
periods, RISK4 is the difference between maximum and minimum ROA over five overlapping years,
RISK_SQ is the squared value of RISK3/RISK4, RISK_REG is the interaction term of RISK3/RISK4 andregulation, NON_EX is non-executive director ratio, REPLACE is replacement director ratio, BSIZE isboard size, FSIZE is firm size, STDEBT is short-term debt maturity, DIV is dividend payout ratio. AR (1)and AR (2) are tests for first-order and second-order serial correlation in the first-differenced residuals
under the null of no serial correlation. Sargan/Hansen test of over-identification is under the null that all
instruments are valid. The instruments are the lags of the explanatory variables, and YEAR dummies aretreated as strictly exogenous variables. Statistically significant at 1% (***), 5%(**), and 10%(*),
respectively.

44

Table 3.5 reports the results of system GMM estimation, according to Arellano &Bover (1995) and Blundell & Bond (1998). To obtain estimates of system GMM, thispaper applies xtabond2 in Stata, where the instruments are the lags of the dependent andexplanatory variables (Roodman, 2009). The study specifies the function for smallsample adjustment and report t-statistics and Wald chi-square as opposed to Z-statistics
and F-tests. The study also uses robust standard errors, which are consistent with panelspecific autocorrelation and heteroskedasticity. Furthermore, year dummies are added
into GMM analysis to capture macro conditions that equally affect all firms. Since
Vietnamese corporate governance reform is mainly driven by the government and a timeframe is set for listed companies to increase non-executive directors and board
independence should increase over the period. Following Wintoki et al. (2012), the study
treats year dummies as strictly exogenous variables.
The interpretation of the results in table 3.5 is similar to those reported in Table 3.3
and Table 3.4. With regard to the impacts of firm risk, the coefficients on firm risk as wellas squared risk are significant for all the columns, reinforcing the aforementioned results.
The results also imply that firm risk is an economically important factor in predicting
whether a firm should adjust board independence or not. From another perspective,
pursuing a stable or risky business strategy is crucial to appointing and inviting nonexecutive directors to the board of directors. This argument is supported by Rosensteinand Wyatt (1990), who suggests that ‘‘the addition of an outside director signals a change
in firm strategy”. Also, the moderating role of regulation remains unchanged, indicatingthat high-risk firms changed their supervisory board structure towards increasing theseparation of ownership and management to comply with the Circular 121/2012/TT-BTC.
In other words, this new regulation significantly contributes to reforming high-risk
companies’ board structure. Because high-risk firms often face significant information
asymmetries and minority shareholders’ benefits are often not guaranteed, such a new
regulation on the corporate governance plays a role in motivating more transparency andthen increasing investors’ confidence. Additionally, the lag of NON_EX is highly
significant, which justifies its inclusion in the model specification. The diagnostics tests
for GMM estimations show that the models are well-fitted with statistically insignificant
test statistics for both second-order autocorrelations in second differences and Hansen
tests of over-identifying restrictions. They indicate that the instruments are valid in theestimation. Finally, the number of instruments used in the model is less than the panel(151), which makes the Hansen tests more reliable.
45

After controlling for potential endogeneity by dynamic GMM regressions, thecoefficients on control variables such as firm size, debt maturity, and dividend payout inTable 3.5 turn out to be insignificantly negative. Regarding firm size, Brick &Chidambaran (2008) also show its impact on the percentage of independent directors ischanged into insignificantly negative by using 2SLS regressions to solve the endogeneity
problem in their model. Meanwhile, STDEBT and DIV variables present a negative sign
as expected above.
In Table 3.6, the study conducts additional robustness checks to make sure that theresults are not spurious. Following John et al. (2008) and Faccio et al. (2011), the study
uses two alternative measures to proxy for firm risk: RISK3 is the volatility of a firm ‘sreturn on assets (ROA) over five-year overlapping periods and RISK4 is the difference
between maximum and minimum ROA over five overlapping years. As reported in Table
3.6, all coefficients on firm risk as well as squared risk are significant for all the columns,
reinforcing the non-linear effect. Regarding regulation, although the effect of REG incolumn 4 is different from those in the other models, its coefficient is significantly
positive. Therefore, the moderating role of REG remains valid. In brief, all the aboverobustness checks provide persuasive evidence of the nonlinear effect of firm risk and themoderating effect of regulation.
3.5 Conclusion
The impact of firm risk on the change in board structure has still received little
attention from researchers, especially for developing countries such as Vietnam. In
addition, building an independent board has become a trend in corporate governance.
Indeed, governments have enacted legislation to re-establish corporate governance after
the past financial market crises which partially stemmed from weak board monitoring. In
Vietnam, the government also issued the Circular 121/2012/TT-BTC dated July 26, 2012,
on corporate governance applicable to public companies, which caused changes in listedcompanies’ supervisory board structure. Hence, this paper investigates the impact of firmrisk on the non-executive director ratio and the moderating effects of regulation to serve
current corporate risk management.
The research results indicated the U-shaped nonlinear impact of firm risk on the nonexecutive director ratio. The monitoring role of non-executive directors became lessimportant when the stock return volatility became higher; however, there is a limit beyond
which the benefits outweigh the costs of monitoring. This result supports that the optimal46

level of monitoring was determined by the tradeoff between the costs and benefits ofmonitoring (Demsetz & Lehn, 1985; Linck et al., 2008). Other outcomes show that in thepresence of regulation, high-risk firms have more incentives to increase the percentage of
non-executive directors because the probability of poor performance is higher for highrisk firms, and the supervisory board is often criticized for having failed in their duties toprotect shareholders, especially for minority shareholders.
However, the study was limited to the identification of non-executive directors’
characteristics. It would, therefore, be interesting to investigate the impact of firm risk on
the proportion of female or foreign non-executive directors. From another perspective,
non-executive directors’ ownership also attracts the attention of researchers, especially inemerging markets. Such further studies could improve the understanding of the nonexecutive directors’ risk management role.
Finally, the findings also offer some implications of corporate governance in Vietnam
as well as in emerging countries. Firstly, decisions on board independence should be madeafter considering environmental and strategic factors. Secondly, improving theregulations on corporate governance towards dispersed ownership and management
control is essential to enhance the quality of governance systems and risk management.
In brief, the effect of firm risk on the proportion of non-executive directors will give moresignificant insights into the role of non-executive directors in Vietnamese listedcompanies and helps lawmakers improve corporate governance legislations.

47

CHAPTER 4: (PAPER 3) FOREIGN OWNERSHIP AND STOCK RETURN
VOLATILITY IN VIETNAM: THE DESTABILIZING ROLE OF FIRM SIZE
4.1 Introduction
Foreign ownership has gradually become an inevitable trend in the era of international
economic integration, in which stock markets play a supporting role in promoting foreign
capital investments into domestic companies (Foong & Lim, 2016). Foreign ownershiphas, in turn, contributed to the development of capital markets and has become an
essential factor in diversifying ownership structure in many listed companies. The
question of whether foreign ownership relates to the development and stability of stock
markets has drawn the attention of academics and policy-makers. However, current
literature has mixed findings on the association between foreign ownership and thefluctuation of stock returns.
Several studies indicated a negative impact. (Wang, 2007; Li et al., 2011; Vo, 2015).
Wang (2007) gives two economic interpretations of a negative relationship between
foreign investment and volatility. First, attracting foreign investors is considered to widen
the investor base for a stock, which leads to greater risk-sharing and lowers volatility(Mitton, 2006; Wang, 2007). It is an investor base-broadening effect which is identified
by Merton (1987). Second, more substantial ownership of foreign shareholders reduces
the capital cost of a firm under the well-known leverage effect theory. In other words,
companies can take advantage of foreign investments instead of debts, which helps toreduce the financial burdens and risks. Besides, foreign investors could improve theinformation quality in local stock markets, provide better corporate control and reporting
standards, enhance the corporate governance environments and thus significantly reducetransaction costs, informational costs (Li et al., 2011; Vo, 2015). Indeed, foreign investors
usually choose well-managed companies to invest, and this should further accelerate
improvement in corporate governance (Leuz et al., 2009). Another explanation is that
foreign investors will appoint representatives or seek experts to coordinate and monitor
corporate governance. Min & Bowman (2015) also support that foreign investors placeconsiderable merit on the appointment of independent directors in the firms listed on the
Korea Exchange.
On the contrary, many other studies showed a positive impact of foreign investment
on firm-level volatility (Bae et al., 2004; Bohl & Brzeszczynski, 2006; Han & Singal,
2000). Bae et al. (2004) suggest that foreign ownership can cause significant firm-level48

return volatility in an emerging market because it makes stock returns more vulnerable to
the world market risk. In other words, the local stock markets are very volatile withforeign capital movements because emerging markets are not very liquid and transparent(Han & Singal, 2000). Besides, many foreign investors pursue short-term or speculative
investment strategies (Bohl & Brzeszczynski, 2006; Stiglitz, 2000), which promotes
frequent trading activities. According to Zhang (2010), a higher trading volume creates
price movements and reflects a higher level of volatility. Also, portfolio adjustments bylarge foreign institutional investors are likely to result in significant price fluctuations(Bae et al., 2004).
In Vietnam, economic reforms under “Doi Moi” policy, which was launched in 1986
to transition the country from a centralized economy to a market-oriented economy,
created a wave of equitization of state-owned enterprises (SOEs) and broadened
opportunities for foreign investors. In the 1990s, the Vietnam stock market had not yet
been established, so restructuring was implemented by focusing on the small-sized andmedium-sized SOEs, and by integrating plural SOEs into groups. Until 2000, the firststock exchange was launched in Ho Chi Minh city with only two listed companies, which
made its milestone in the transitional process of Vietnam’s economy.
Under international economic integration, the gradual removal of the restrictions on
foreign ownership has boosted foreign capital inflows into the Vietnam stock market (My& Truong, 2011). Notably, the Decree No. 60/2015/ND-CP permits foreign investors to
own up to 100 percent of the equity (instead of 49 percent as promulgated before) in mostpublic Vietnamese companies, except for companies in specific restricted sectors. The
increased presence of foreign investors is expected to improve transparency for listedcompanies and hence provide stock price stabilization. Therefore, it drives us toinvestigate whether attracting more foreign ownership can be considered as a mechanism
to control stock return volatility for the listed firms.
However, foreign investors in many large listed companies in the Vietnam stock
market are usually large financial institutions. Their high proportions of equity canpromote them to become large shareholders with the opportunities to divert firm resources
for their own benefits at the expense of minority shareholders (entrenchment effect). To
hide their self-serving behaviors, entrenched large shareholders usually withhold
unfavorable information or selectively disclosing information (McConnell & Servaes,
1990), which can lead to more information asymmetries. The impact of foreign investors
on stock return volatility in such firms should be thus evaluated with more caution.
49

Most studies related to foreign ownership in Vietnam mainly focus on its impact on
performance rather than stock return volatility, except for Vo (2015). However, the study
provides a more general empirical investigation for the entire Vietnamese stock market
while Vo (2015) only focuses on studying the firms listed on the Ho Chi Minh City stock
exchange which is one of the two largest stock exchanges in Vietnam. More significantly,
the study does not only examine the direct influence of foreign ownership on the volatilityof stock returns but also further consider this association in relation to firm size. It helps
to bring a thorough explanation of foreign investors’ participation in stock return
volatility in the context of an emerging market.
The main results of this study regarding the influence of foreign ownership on stock
return volatility are as follows. The estimated regressions show a negative effect offoreign ownership on stock return volatility after controlling for firm characteristics andpotential endogeneity problems. It indicates that the increased presence of foreign
investors contributes to stabilizing the firm-level fluctuation of stock returns because they
have many advantages (such as substantial capital, investment experiences) to manage
risks, as well as enhance a better corporate governance environment. From a different
perspective, foreign investors in Vietnam tend to invest long-term and hold more strategic
portfolios, which also explains the low return volatility. However, the negative influenceof foreign ownership becomes weaker in large firms because large foreign investors insuch firms tend to become majority shareholders and have the power for entrenchment.
The paper process is as follows: Section 2 reviews the impact of foreign ownershipon stock return volatility in the Vietnam stock market and the destabilizing influence offirm size. Section 3 presents the model and data. Section 4 shows the results of theempirical analysis. A conclusion is provided in section 5.
4.2 Literature review
4.2.1. The impact of foreign ownership on stock return volatility in the Vietnam
stock market.
Vietnam's securities law was issued in 2006 and amended in 2010 but did not cite
foreign ownership limits. However, Decision No. 238/2005/QD-TT on the percentage of
foreign parties’ participation in the Vietnam securities market was considered as the big
step towards attracting foreign investment capitals, by raising the limit on foreign holdingof listed companies’ stocks from 30 percent to 49 percent. Then, it was replaced by
Decision No. 55/2009/QD-TT on holding rates of foreign investors in the Vietnam
50

securities market, but the 49 percent foreign ownership cap on most local companies
remained in force until 2015.
As an effort to attract more foreign investors in the Vietnam stock market, thegovernment issued Decree No. 60/2015/ND-CP on 26 June 2015, amending andsupplementing several articles of Decree No. 58/2012/ND-CP dated 20 July 2012providing details and implementation guidelines on several articles of the Law on
Securities. Among the changes, the most welcomed amendment is that public companies
operating in unconditional sectors can remove foreign ownership limits. Although themove helped the listed companies to remove the limit and seek more foreign investors,
only a handful of firms, including Vinamilk, Domesco Medical Import Export, and DHG
Pharma, raised limits.
Figure 4.1: The percentage of foreign trading volume over the whole market
14.00
12.00
10.00
8.00
6.00
4.00
2.00
0.00

2009

2010

2011

2012

2013

2014

2015

2016

2017

Buying volume (%)

6.75

8.71

10.97

8.64

8.13

6.35

8.08

7.47

7.38

Selling volume (%)

6.30

6.47

11.54

8.23

7.58

5.68

7.41

8.13

6.78

Buying volume (%)

Selling volume (%)

Source: Data from Ho Chi Minh Stock Exchange
Foreign ownership is expected to provide better corporate governance andtransparency improvement in the listed companies. First, many large firms in the Vietnam
stock market have historically been inefficient state-owned companies, so the equitization(i.e. partial privatization) and divestment of state-owned enterprises to foreign investors
aim to promote their efficiency. Second, foreign investors in Vietnamese listed companies
tend to be institutions (such as mutual funds, hedge funds, and foreign investment banks)51

with a long history of successful investment in many other stock markets. The annual
reports of the Vietnam Security Depository (www.vsd.vn) also prove that the growth offoreign institutional trading accounts is higher than that of foreign individual trading
accounts. The total number of foreign trading accounts rose from 11,257 accounts in 2008
up to 22,561 accounts in 2017 (a 2-fold increase); of which the number of foreign
institutional trading accounts increase from below 1,000 accounts in 2008 to 2,865
accounts in 2017 (more than 2.8 times). Such financial institutions are expected to
improve the corporate governance environments as well as control stock price volatility
better.
Another study by Vo (2016b) adds that foreign investors in the Vietnam stock market
focus on long-run perspectives rather than short term gain, by investigating the impact offoreign ownership on the corporate risk-taking activity for a sample of 263 Vietnameselisted companies in the 2007-2014 period. In other words, they pursue an inactive buyand-hold investment strategy, which reduces the need for frequent trading for pricediscovery (Batten & Vo, 2015; Nguyen, 2017). Their low proportions of the trading
volume and tendency towards the net purchase, as shown in figure 4.1, also support thisstrategy. Also, their trading activities tend to become the pattern for domestic investors(Nguyen, 2017). These findings also contribute to explaining the stability of stock prices
from a trading perspective.
From the above arguments, the study expects that foreign ownership has a negative
impact on stock return volatility.
4.2.2 Firm size, foreign ownership, and stock return volatility
Many previous studies indicate that foreign investors favor large and well-operated
firms (Dahlquist & Robertsson, 2001; Kang & Stulz, 1997; Lin & Shiu, 2003). First,
small-size firms are usually limited in their resources and experience to attract foreign
investors, while large firms have more financial and technical capabilities, the economies
of scope (Damanpour, 2010). Second, large firms tend to have fewer competitors thanks
to their monopoly power. Tsang (2005) also finds that the level of foreign ownershipshould be negatively associated with the degree of industrial competition. Third, thesefirms do not only have their financial performance but also transparency and disclosure,which is taken into more consideration by foreign investors, especially in emerging stock
markets. Another reason is that small-sized firms’ market capitalization is too small forlarge institutional investors, which drives foreign investors to narrow their options tolarger firms. Batten & Vo (2015), who investigate the determinants of foreign ownership52

in the Vietnam stock market, also indicate that foreign investors allocate a
disproportionately high share of their capitals to large firms.
Holding a high proportion of equity, large financial institutions in Vietnam tend to

become majority shareholders and increase control over corporate decisions to serve theirown interests against those of other investors under the entrenchment effect perspective.
Brockman & Yan (2009) also support that the increase in foreign ownership can also
cause more information asymmetries. Besides, Vo (2016c) states that firms with
substantial foreign ownership have a close tie with local governments, especially inemerging markets with weak corporate governance and poor institutional aspects. Hence,
this study also raises the question of whether the stabilizing effect of foreign ownershipon the fluctuation of stock returns become weaker in large firms.
4.3. Data and methodology
4.3.1 Model specification
According to Chen et al. (2013) and Vo (2015), the impact of foreign ownership on
stock return volatility is presented as follows:୧୲ = Ⱦ଴ + Ⱦଵ ୧୲ + σ Ⱦ୩ *୧୲ + ɂ୧୲(4.1)

Furthermore, the study also wants to further investigate this relationship under thedestabilizing effect of firm size. Consequently, the above model is restructured inequation (4.2):
୧୲ = Ⱦ଴ + Ⱦଵ ୧୲ +Ⱦଶ ୧୲ *  ୧୲ + σ Ⱦ୩ *୧୲ + ɂ୧୲ (4.2)
Following Cosset et al. (2016) and Hasan et al. (2017), the study uses two measuresof stock return volatility (VOLit): (i) the standard deviation of daily stock returns on afiscal year basis and (ii) the standard deviation of the residuals from the market model:
Rit = αi + βiRMt + εit on a fiscal year basis (Rit donates the daily stock returns; RMt
represents the daily market returns based on the VN-index; the εi,t stands for the residuals).
FOWNit is the proportion of shares held by foreign investors. Controlit are controllingvariables.
The regression model also incorporates the other variables that previous studies
suggest might affect VOL. 1. Firm size (FSIZE) is calculated as the natural logarithm oftotal assets. According to Vo (2015), stock return volatility is driven by firm
characteristics, particularly firm size. Pástor & Veronesi (2003) also find a negative
relation between return volatility and firm size. 2. Leverage (LEV) is measured as theratio of total liabilities to total assets. The stock price of highly leveraged firms tends to53

be more volatile since these firms are supposed to have higher bankruptcy risk (Wei &Zhang, 2006; Chen et al.,2013). 3. Returns on equity (ROE) is defined as net income
divided by shareholders' equity. Both Pastor & Veronesi (2003) and Wei & Zhang (2006)
confirm that firms with lower ROE are expected to experience higher stock return
fluctuations. 4. Two control variables to capture board composition characteristics: Nonexecutive director ratio (NON_EX) is measured as the number of non-executive directors
to total board members, and board size (lnBSIZE) is calculated as the natural logarithmof total members on board. Many studies such as Cheng (2008), Pathan (2009), Nakano& Nguyen (2012), Huang & Wang (2015) prove that corporate risk is related to board
size and board independence. 6. State ownership (STATE) is the number of shares heldby the state to the total number of shares outstanding. This variable is included in themodel because Vietnam historically installed a centralized economy characterized bystate ownership. Moreover, state ownership tends to offer policy and resource benefits(Zhou et al., 2017), which allow state-owned companies to reduce volatility. 7. Price tobook value (PB) is the ratio of the market value of equity to the book value of equity,which is a proxy for growth opportunity. 8. Stock liquidity (LIQ) is calculated as the
proportion of trading days in one year in which the stock return is non-zero. This variable
should be controlled in the model because the movements of the stock price are highly
associated with trading activities (Zhang, 2010). 9. Firm age (lnFAGE) is also included
because the corporate risk is found to be higher for younger firms (Bartram et al., 2012;
Rubin & Smith, 2009). The study also includes industry and year fixed effects to control
for industry-specific and aggregate time-varying factors.
4.3.2 Data
The research sample comprises of 160 non-financial companies listed on Vietnamesestock markets (including HNX - Hanoi Stock Exchange and HOSE – Ho Chi Minh Stock
Exchange) from 2008 to 2017. The listed companies are classified according to theIndustry Classification Benchmark (ICB) 2008 applied in Vietnam.
The data was collected from various sources: governance-related variables such as
foreign ownership, state ownership, and non-executive director ratio were manually
collected reviewing annual reports which are available on the www.vietstock.vn (aleading website providing financial information, market data, and investing tools for
institutional and individual investors in Vietnam). The other financial variables werecollected from DataStream. Any additional data or information is directly gathered fromcompanies’ websites if necessary. From DataStream, the study used a list of companies
54whose stock price is available from January 1rst, 2008. The sample consisted of 219
companies after financial companies such as banks, securities, insurance, and financial
services were excluded because these companies act as market makers. Additionally, theforeign ownership restrictions in the listed banks are stricter than the other listedcompanies. For a long time, Viet Nam imposed restrictions on foreign ownership indomestically listed firms: up to 49 percent of the equity for the listed companies and up
to 30 percent for the listed banks. Since the Decree No. 60/2015/ND-CP took effect, thegovernment has removed the existing 49 percent foreign ownership cap on the listed firms,
but the foreign ownership limit in the banking industry has remained unchanged at 30
percent. In the process of collecting the governance-related data, the study continued to
exclude 59 companies due to too many missing observations.
4.4. Results and discussions
4.4.1. Descriptive statistics and correlation
Table 4.1: Description statistics

VOL1 (%)
VOL2 (%)
FSIZE
LEV
ROE
PB
LIQ
NON_EX
BSIZE
FAGE
STATE (%)
FOWN (%)

Obs
1600
1600
1600
1600
1600
1589
1600
1600
1600
1600
1593
1340

Mean
3.03
2.75
20.30
0.48
0.13
1.13
0.73
0.57
5.52
6.79
31.63
11.91

SD
1.14
1.12
1.44
0.22
0.16
0.91
0.19
0.20
1.18
3.30
22.85
14.67

25th
50th
75th
Min percentile percentile percentile
1.06
2.35
2.98
3.58
0.93
2.14
2.62
3.27
16.31
19.27
20.19
21.23
0.02
0.30
0.50
0.66
-2.32
0.06
0.12
0.19
0.13
0.60
0.91
1.40
0.02
0.65
0.78
0.88
0.00
0.40
0.60
0.75
2
5
5
6
1
4
7
9
0
8.19
34.71
51.00
0
1.37
4.84
17.39

Max
32.99
33.05
24.69
0.95
3.34
12.95
0.99
1.00
11
17
84.44
65.16

Notes: The table presents descriptive statistics among the variables of this study, where VOL1 and VOL2 are the two
measures of the stock return volatility, FOWN is the proportion of shares held by foreign investors, FSIZE is the natural
logarithm of total assets, LEV is the ratio of total liabilities to total assets, ROE is return on equity, PB is the ratio of
the market value of equity to the book value of equity, LIQ is the proportion of trading days in one year in which thestock return is non-zero, NON_EX is the percentage of non-executive directors on board, BSIZE is the total numberof directors on board, STATE is the proportion of shares held by state shareholders, FAGE is the number of years fromthe time the company is listed for the first time in the Vietnam stock market. For interpretation purposes, the descriptive
statistics of board size and firm age are calculated on the basis of levels instead of logarithmic form.

Table 4.1 presents the summary statistics of the sample on board and ownership
structure, as well as firm characteristics. The mean (median) of foreign ownership in thesample is 11.91% (4.84%), quite close to the reported figures (12.29% and 5.98%) by Vo55

(2015) for a sample of 268 non-financial firms listed on the Ho Chi Minh stock exchange
in the 2006-2012 period. The two volatility measures do not have much difference in theirmean values (3.03 and 2.75) and standard deviations (1.14 and 1.12).
Table 4.2: Correlation matrix
VOL1 VOL2 FOWN FSIZE LEV ROE NON_EX lnBSIZE STATEPB LIQ VIFs
FOWN -0.30 -0.31
1.77
FSIZE
-0.34 -0.37 0.42
2.11
LEV
0.10 0.10 -0.28 0.26
1.42
ROE
-0.10 -0.14 0.18 0.08 -0.11
1.13
NON_EX -0.04 0.00 0.10 0.11 -0.08 -0.04
1.09
lnBSIZE -0.17 -0.19 0.36 0.33 -0.04 0.04
0.02
1.25
STATE -0.02 -0.05 -0.15 0.05 0.07 0.06
0.07 -0.17
1.17
PB-0.13 -0.14 0.38 0.19 -0.17 0.25
0.10
0.11 0.02
1.24
LIQ-0.01 -0.21 0.19 0.37 0.00 0.18
-0.03
0.17 -0.05 0.07
1.73
lnFAGE -0.23 0.01 0.11 0.13 -0.04 -0.17
0.21
0.01 -0.17 0.02 -0.44 1.64
Note: The table presents correlation matrix among the variables of this study, where VOL1 and VOL2 are the two
measures of the stock return volatility, FOWN is the proportion of shares held by foreign investors, FSIZE is thenatural logarithm of total assets, LEV is the ratio of total liabilities to total assets, ROE is return on equity, PB is theratio of the market value of equity to the book value of equity, LIQ is the proportion of trading days in one year inwhich the stock return is non-zero, NON_EX is the percentage of non-executive directors on board, lnBSIZE is thenatural logarithm of the total number of directors on board, STATE is the proportion of shares held by stateshareholders, lnFAGE is the natural logarithm of firm age. VIFs are variance inflation factors.

As reported in Table 4.2, FOWN is negatively related to VOL1 and VOL2, which isconsistent with the above expectation. The correlation matrix gives no suggestion to any
serious multicollinearity concerns since none of the correlation coefficients among
independent variables are larger than the value of 0.8. The study also calculates thevariance inflation factors (VIFs) to check again for any multicollinearity issue in themodel, but all VIFs are low, with a mean of 1.46 (not reported in the table). It is supported
by Chatterjee & Hadi (2015) who suggest that a value of VIF larger than 10 indicates thepresence of a multicollinearity problem.
4.4.2. The impacts of foreign ownership and firm size
Table 4.3 provides the estimated results of foreign ownership on stock return volatility
by using year and industry fixed effects regressions with firm-level clustered standard
errors. The study uses both current and one-year future volatility as proxies for the
dependent variable. According to Wang (2013), the future one-year volatility helps tobetter confirm the causal effect of foreign ownership on stock return volatility. After
controlling for some board characteristics (such as board independence, board size, state56

ownership) and the other firm characteristics, the study finds that the coefficients on
FOWN are statistically negative. This result implies the role and benefits of foreign
investors in enhancing better corporate governance and reducing information
asymmetries, especially when many listed firms in the Vietnam stock market havehistorically been inefficient state-owned companies. Foreign investments in Vietnamese
firms also play an essential role as an alternative financial source under well-known
leverage effect theory. From a trading behavior perspective, the negative impact ofownership can be explained by the buy-and-hold investment strategy because they tend
to be long-term investors, rather than short-term speculators.
The obtained result supports the first hypothesis, indicating that a high proportion offoreign ownership plays as one of the determinants to mitigate the fluctuation of stock
returns. The finding is in line with that of the previously published studies in otheremerging countries. Wang (2013) showed the calming effect of foreign ownership on
stock return volatility for a sample of Indonesian firms listed on the Jakarta Stock
Exchange from 1996 to 2000. Another study by Li et al. (2011) confirms that thestabilizing effect of large foreign ownership is present in 31 emerging markets. Both
Wang (2013) and Li et al. (2011) imply that establishing an ownership structure towards
international liberalization and integration is crucial to risk management.
Regarding the effect of firm size, the coefficients on FSIZE are negative andsignificant in all regressions, thereby confirming that large firms tend to reduce stock
return volatility due to their better governance and less information asymmetry. The
negative relationship also supports the viewpoint of Damanpour (2010) that larger
companies are also recognized to have more advantages to control stock price fluctuations.
4.4.3. The destabilizing role of firm size
Regarding the destabilizing effect of firm size on the relationship between foreign
ownership and stock return volatility, the estimated coefficient on the interaction term
between FOWN and FSIZE turns out to be positive at the significance level of 0.01 in
Table 4.3. The converse results on FOWN suggests that firm size tends to weaken theforeign ownership-volatility relationship. In other words, the presence of foreign
investors in large firms helps to decrease the stability of stock prices. It is because mostof the foreign shareholders in such firms are large financial institutions whose highproportion of equity is associated with board membership. As majority shareholders andcorporate insiders, such foreign investors tend to retain weak corporate governance or57deters the release of specific-firm information to the market on purpose of easily
facilitating their potential expropriation. Such inadequate information disclosure causes
more information asymmetries between minority and majority shareholders, which leads
to more volatility.
In line with the viewpoint, Viet (2013) also give two significant contributions to
explain foreign investors’ behavior in the Vietnam stock market, by using a sample of407 non-financial listed firms from 2006 to 2010. First, foreign investors seem to preferfirms with large size and higher market reputation. Second, there exists an inverted Ushaped relationship between foreign ownership and firm performances, which indicatesthat the negative effects of foreign shareholders on firm performance may occur if theirownership reaches a certain high level. He explains that a too high level of foreign
ownership can allow foreign investors to influence several vital aspects of invested firms
and weaken firm efficiencies.
To investigate the second hypothesis in more details, the original sample is divided
into two subsamples, corresponding to small and large firms, by comparing the firm sizeof each firm operating in a given industry in a given year with the average firm size of all
firms operating in the same industry during that year. The estimates presented in Table
4.4 show that foreign ownership has a weaker significant impact on current volatility andan insignificant impact on future volatility in large firms. Moreover, the negative
coefficients on FSIZE have smaller absolute values for large firms. All these results
confirm the destabilizing role of firm size.
4.4.4. Potential endogeneity and robustness tests
Although unobservable heterogeneity can be eliminated by the application of the
fixed effects model, the estimated coefficients may still be biased if the dependent
variable and explanatory variables are simultaneously determined. According to Roberts& White (2012) and Wintoki et al. (2012), this endogeneity problem should be taken into
more consideration because it can undermine causal inference in corporate governancestudies. The studies by Vo (2015), Li et al. (2011), and Chen et al. (2013), examining theimpact of foreign ownership on stock return volatility in emerging markets, mention thepossibility of endogeneity problem in their model by referring the previous studies indeveloped countries such as Kang & Stulz (1997) and Dahlquist & Robertsson (2001).
However, all their results are not changed after they apply first-difference regressions, IV
regressions, and GMM regressions to address the potential endogeneity. Chen et al.
58

(2013) even conclude that their study is less subjective to the potential endogeneity
problems. Despite that, the study still re-estimates the model by instrumental variable
regressions with industry and year fixed effects to check the robustness of the estimates.
Besides, according to Adams & Ferreira (2007) and Raheja (2005), high information
asymmetry discourages firms from increasing the monitoring activities from independent
directors because it is costly to transfer firm-specific information to outsiders, especiallywhen the supervising role of independent directors is proved to be not inefficient in an
emerging market like Vietnam (Van Tuan & Tuan, 2016). The positive coefficients on
NON_EX in Table 4.3 also support this viewpoint. In other words, high return volatility
in a period may lead to a change in the non-executive ratio. Thus, NON_EX variable islikely to be another endogenous variable.
To address the potential problems, the study uses FOWNt-1 (the lagged value of
foreign ownership) as an instrument for FOWN (Han et al., 2015). Another potential
instrument for FOWN is DIR_EXP (the average working years of the directors in thecompany) because boards with long-serving members tend to be averse to strategicchange and reluctant to internationalization (Golden & Zajac, 2001), which deters foreign
investment. According to Li (1994) and Mak & Li (2001), board size has a negative
impact on the composition of outside board members. Besides, individual director
attributes (such as directors’ age, experience, and so on) are associated with theenvironment in which non-executive directors perform their duties. Therefore, the study
uses ∆lnBSIZEt-1 (the lag of the change in lnBSIZE), DIR_EXP (the average working
years of the directors in the company), DIR_AGE (the average age of the directors on
board) as instrumental variables for NON_EX. Then, F-tests and Hansen tests of overidentifying restrictions are necessary to confirm the validity of these instruments.
The study shows that the negative relationship between foreign ownership andvolatility is not changed in table 4.5 and Table 4.6. All the coefficients on FOWN are
significantly negative, confirming the risk-controlling role of foreign investors as well as
their long-term investment strategy. Regarding the second hypothesis, the destabilizingrole of FSIZE remains valid because all the estimated coefficients on the interaction term
are still significantly positive in Table 4.6. Besides, the validity of the instruments can bejustified by an obtained F-statistics of more than 10 in the first-stage regression and
Hansen tests of over-identifying restrictions indicate that the instruments are notcorrelated with the error term. All the diagnostics tests support the conclusion that the
instruments used are reasonable, and the regression results are consistent.
59ConstantlnFAGE

LIQ

PB

STATE

lnBSIZE

NON_EXROELEVFOWN*FSIZE

FSIZE

FOWN

0.593**(2.04)-0.504***(-4.17)0.343**(2.18)-0.389**(-2.12)-0.00236(-0.96)0.00427(0.11)
0.239(0.65)-0.170(-1.46)
7.799***

0.633**(2.23)-0.502***(-4.10)0.361**(2.30)-0.417**(-2.33)-0.00210(-0.87)-0.0121(-0.31)0.258(0.70)-0.128(-1.16)8.722***

VOL1-0.00985***-0.0818***(-2.95)(-3.38)-0.210***-0.259***(-5.40)(-6.51)0.00345***(3.11)
0.655**(2.31)-0.432***(-3.88)0.358**(2.32)-0.368**(-2.00)-0.00213(-0.88)-0.00412(-0.11)-0.168(-0.44)-0.143(-1.20)8.731***
60

0.691**(2.48)-0.431***(-3.80)0.374**(2.40)-0.394**(-2.16)-0.00190(-0.80)-0.0189(-0.50)-0.151(-0.39)-0.106(-0.91)
9.563***

VOL2-0.00847***-0.0733***(-2.63)(-2.93)-0.261***-0.305***(-6.42)(-7.13)0.00311***(2.69)

Current volatility

Table 4.3: Industry and year fixed effects regressions

0.502(1.56)-0.730**(-2.38)0.453***(2.72)-0.350*(-1.66)-0.00257(-1.02)-0.0312(-0.60)-0.476**(-2.00)-0.0902(-0.71)
7.459***

0.550*(1.74)-0.719**(-2.35)0.474***(2.83)-0.366*(-1.79)-0.00231(-0.93)-0.0482(-0.89)-0.458*(-1.92)-0.0455(-0.38)8.438***

0.575*(1.82)-0.654**(-2.20)0.450***(2.78)-0.331(-1.55)-0.00201(-0.82)-0.0368(-0.72)-0.710***(-2.84)-0.0507(-0.39)8.508***

0.618**(1.99)-0.644**(-2.17)0.470***(2.86)-0.346(-1.64)-0.00177(-0.73)-0.0522(-0.99)-0.693***(-2.77)-0.0100(-0.08)9.399***

Future one-year volatility
VOL1(t+1)
VOL2(t+1)-0.00860**-0.0868***-0.00776**-0.0789***(-2.41)(-3.12)(-2.25)(-2.79)-0.179***-0.232***-0.239***-0.288***(-5.63)(-6.19)(-7.21)(-7.37)0.00376***
0.00342***(2.93)(2.62)

(11.81)
1329
Yes
Yes
23.08
0.000
0.2434(13.45)
1329
Yes
Yes
26.65
0.000
0.2313(12.13)
1329
Yes
Yes
26.47
0.000
0.2340(10.46)
1188
Yes
Yes
17.14
0.000
0.2209(9.54)
1188
Yes
Yes
16.24
0.000
0.2245(11.73)
1188
Yes
Yes
21.78
0.000
0.2349(10.37)
1188
Yes
Yes
20.52
0.000
0.2379NON_EX

ROE

LEV

FSIZE

FOWN

VOL1
-0.00849**(-2.42)-0.127**(-2.58)0.871***(4.20)-0.376***(-3.76)0.270(1.60)

VOL2-0.00642*(-1.98)-0.205***(-3.95)0.914***(4.35)-0.298***(-3.32)0.284*(1.73)

Large firms

61

VOL2
-0.0131**(-2.49)-0.372***(-3.90)0.699(1.44)-0.733*(-1.76)0.364(1.52)

Small firms
VOL1-0.0133**(-2.51)-0.337***(-3.58)0.663(1.34)-0.894**(-2.14)0.366(1.50)

Current volatility

Table 4.4: Industry and year fixed effects regressions with sub-samples
Future one-year volatility
Large firms
Small firms
VOL1(t+1)
VOL2(t+1)
VOL1(t+1)
VOL2(t+1)-0.00526-0.00392-0.0132**-0.0136**(-1.48)(-1.17)(-2.39)(-2.44)-0.112**-0.202***-0.275***-0.319***(-2.42)(-4.13)(-3.58)(-4.18)0.857***
0.925***
0.522
0.559
(3.98)(4.30)(1.04)(1.13)-0.289**-0.239*-1.845***-1.770***(-2.19)(-1.79)(-3.70)(-3.59)0.424**
0.420**
0.402
0.378(2.56)(2.55)(1.58)(1.52)

Note: This table presents industry and year fixed effects regressions to examine the relationship between foreign ownership and stock return volatility. VOL1 and VOL2 are thetwo measures of the stock return volatility, FOWN is the proportion of shares held by foreign investors, FSIZE is the natural logarithm of total assets, LEV is the ratio of total
liabilities to total assets, ROE is return on equity, NON_EX is the percentage of non-executive directors on board, lnBSIZE is the natural logarithm of the total number of
directors on board, PB is the ratio of the market value of equity to the book value of equity, LIQ is the proportion of trading days in one year in which the stock return is nonzero, STATE is the proportion of shares held by state shareholders, lnFAGE is the natural logarithm of firm age. Robust t-statistics adjusted for firm-level clustering are reported
in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

Observations
Year fixedIndustry fixed
F-statistics
P-valueR-squared(12.48)
1329
Yes
Yes
22.27
0.000
0.2400

634
Yes
Yes
20.44
0.000
0.5299-0.433**(-2.22)-0.00135(-0.64)0.00498(0.15)
0.440(1.50)-0.0995(-0.95)5.629***(5.51)

634
Yes
Yes
18.06
0.000
0.4495-0.342*(-1.70)-0.00166(-0.76)0.0135(0.43)-0.436(-1.52)-0.118(-0.99)7.457***(7.04)
695
Yes
Yes
7.35
0.000
0.1579-0.356(-1.01)-0.00358(-0.82)-0.00726(-0.07)0.504(0.82)-0.0938(-0.58)9.987***(6.93)
695
Yes
Yes
7.14
0.000
0.1524-0.392(-1.14)-0.00282(-0.67)-0.0321(-0.29)0.184(0.29)-0.0244(-0.16)
10.59***(7.40)
569
Yes
Yes
20.22
0.000
0.5068-0.138(-0.70)-0.000770(-0.38)-0.0552(-1.21)-0.874***(-3.34)-0.0786(-0.76)5.626***(6.06)
569
Yes
Yes
23.46
0.000
0.4945-0.107(-0.52)-0.000741(-0.36)-0.0374(-0.86)-1.451***(-5.17)-0.0537(-0.45)
7.574***(8.01)
619
Yes
Yes
5.47
0.000
0.1492-0.454(-1.13)-0.00336(-0.75)0.0120(0.11)
0.0433(0.13)
0.0739(0.42)
9.039***(5.51)
619
Yes
Yes
5.65
0.000
0.1545-0.441(-1.11)-0.00227(-0.52)0.00290(0.03)-0.129(-0.37)0.130(0.74)
9.740***(6.02)

62

Note: This table presents industry and year fixed effects regressions to examine the relationship between foreign ownership and stock return volatility. VOL1 and VOL2 are thetwo measures of the stock return volatility, FOWN is the proportion of shares held by foreign investors, FSIZE is the natural logarithm of total assets, LEV is the ratio of total
liabilities to total assets, ROE is return on equity, NON_EX is the percentage of non-executive directors on board, lnBSIZE is the natural logarithm of the total number of
directors on board, PB is the ratio of the market value of equity to the book value of equity, LIQ is the proportion of trading days in one year in which the stock return is nonzero, STATE is the proportion of shares held by state shareholders, lnFAGE is the natural logarithm of firm age. Robust t-statistics adjusted for firm-level clustering are reported
in parentheses. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively.

Observations
Year fixedIndustry fixed
F-statistics
P-valueR-squared

ConstantlnFAGE

LIQ

PB

STATE

lnBSIZE

lnBSIZE

ROE

LEVControl variables
FSIZE

FOWN

Instrumented
NON_EX

DIR_AGE

DIR_EXPFOWN(t-1)

Instruments∆lnBSIZE(t-1)

0.00616(0.49)-0.0754(-1.29)-0.0255(-0.61)
0.0674-0.107**(-1.97)0.000121(0.12)-0.134***(-7.68)0.252**(2.39)

0.575**(2.55)-1.776(-1.64)
1.646*(1.75)
2.162*

2.194(1.43)
0.886***(35.01)-0.536*(-1.67)2.029(0.87)-0.197***(-4.09)0.574*(1.70)-0.463***(-3.90)-0.404*1.714**(2.43)-0.0109**(-2.37)63-0.238***(-4.92)0.608*(1.85)-0.395***(-3.51)-0.394*

1.551**(2.27)-0.0103**(-2.38)Current volatility
First stage
Second stage
NON_EX
FOWN
VOL1
VOL2

Table 4.5: Instrumental variable regressions with year and industry fixed effects

0.00434(0.34)-0.0764(-1.23)-0.0316(-0.54)0.0703-0.0987*(-1.82)0.000245(0.23)-0.135***(-7.34)0.306***(2.71)

0.571**(2.49)-2.240*(-1.92)
1.403(1.27)
2.516*

3.216*(1.90)
0.876***(30.26)-0.633*(-1.88)2.132(0.83)-0.156***(-3.20)0.514(1.36)-0.559**(-2.38)-0.3702.385**(2.01)-0.0109**(-2.04)-0.210***(-4.37)0.559(1.53)-0.498**(-2.14)-0.3692.225*(1.89)-0.0102**(-2.05)

Future one-year volatility
First stage
Second stage
NON_EX
FOWN
VOL1(t+1)
VOL2(t+1)(1.76)-0.0114(-1.38)0.691***(3.75)-0.576(-0.49)-0.703(-0.69)
1092
Yes
Yes

3.008
0.22222.766
0.2508(-1.77)-0.00497(-1.58)-0.0280(-0.53)-0.289(-0.67)-0.238(-0.95)

1092
Yes
Yes

(-1.74)-0.00518(-1.59)-0.0251(-0.47)0.0894(0.21)-0.297(-1.14)959
Yes
Yes
283.96
0.000

15.72
0.000

(1.87)-0.00772(-0.89)0.828***(3.25)-0.848(-0.68)-0.833(-0.81)

959
Yes
Yes

(1.03)
0.00133**(2.31)
0.0161(1.35)
0.0535(0.92)
0.132**(2.22)

3.065
0.2160

959
Yes
Yes

(-1.23)-0.00541(-1.33)-0.0788(-0.98)-0.697**(-2.37)-0.253(-0.76)2.617
0.2702

959
Yes
Yes

(-1.28)-0.00512(-1.30)-0.0774(-0.99)-0.910***(-3.08)-0.226(-0.70)64

Note: This table presents instrumental variable regressions with industry and year fixed effects to confirm the relationship between foreign ownership and stock return volatility.
FOWN and NON_EX are treated as potentially endogenous variables. ∆lnBSIZEt-1 (the lag of the change in lnBSIZE), FOWNt-1 (the lag of foreign ownership), DIR_EXP (theaverage working years of the directors in the company), DIR_AGE (the average age of the directors on board) are instrumental variables. The other variables are defined as thesame as in Table 4.3. The first-stage F test is used to test for the joint significance of the instruments. Hansen test for overidentifying restrictions is tested with the null hypothesisthat the excluded instruments are not correlated to the error term. Robust t-statistics adjusted for firm-level clustering are reported in parentheses. ***, **, and * denotesignificance at the 1%, 5%, and 10% levels, respectively.

Observations
1092
1092
Year fixed
Yes
Yes
Industry fixedYes
Yes
F test of excluded instruments:
F-statistics
18.21
372.73P-value
0.000
0.000
Overidentification test of all instruments
Hansen J-statistics
P-valuelnFAGE

LIQ

PB

STATE

(1.08)
0.00135**(2.52)
0.0151*(1.74)
0.0470(0.85)
0.145**(2.42)

LEV

FSIZE

Control variables

FOWN*FSIZE

FOWN

NON_EX

Instrumented

DIR_AGE

DIR_EXPFOWN(t-1)*FSIZE

FOWN(t-1)∆lnBSIZE(t-1)

Instruments-2.073*(-1.84)(-1.43)(3.14)(1.11)-0.08360.937***(0.99)(2.50)

0.0161

2.387(-1.64)(-7.66)

0.262**-0.536(-2.28)(-1.43)-0.134***-0.0236**(6.46)-0.000651

1.380***(1.44)(1.46)(-1.95)0.0138

2.243

FOWN

First stage-0.105*

NON_EX(-1.86)-44.82*(3.26)

21.71***(1.08)

56.12(-1.66)-11.59*(1.84)

0.428*(2.00)

9.494**(1.39)

45.48

FOWN*FSIZE

Current volatility(1.94)

0.634*(-5.12)65(2.07)

0.659**(-5.67)-0.301***(2.27)(2.61)-0.272***0.00396**(-2.49)(-2.84)0.00463***-0.0929**(2.27)(2.43)-0.108***1.538**

1.700**

VOL2

Second stage
VOL1(-1.37)-0.0854(0.99)

0.0149(2.77)

0.310***(-7.26)-0.135***(-1.47)-0.000691(1.48)

0.0147(-1.77)-0.0964*

NON_EX(-2.14)-2.622**(3.15)

1.019***(0.87)

2.326(-1.77)-0.608*(-2.65)-0.0293***(6.62)

1.488***(1.94)

3.314*FOWN

First stage(-2.17)-56.65**(3.28)

23.61***(0.93)

53.50(-1.78)-13.07*(1.18)

0.292(2.41)

12.09**(1.89)

68.77*FOWN*FSIZE(1.62)

0.588(-3.61)-0.239***(2.01)

0.00518**(-2.15)-0.118**(2.01)(1.78)

0.620*(-4.27)-0.280***(1.72)

0.00432*(-1.86)-0.0998*(1.89)

2.238*

VOL2(t+1)

Second stage

VOL1(t+1)2.401**

Future one-year volatility

Table 4.6: Instrumental variable regressions with year and industry fixed effects for the model including an interaction term.

Yes

Industry fixed

0.000

P-value

0.000

373.70

Yes

Yes

0.000

346.39

Yes

Yes

1092

(-0.92)-21.34(-0.81)-20.35(3.91)

17.84***(-1.68)-0.318*(1.88)

52.30*(1.64)

34.08

3.615

Yes

Yes

1092

(-0.99)-0.238(0.37)

0.153(-0.89)-0.0499(-1.50)-0.00471(-1.98)-0.446**(-3.77)-0.461***

3.704

Yes

Yes

1092

(-0.79)-0.188(-0.55)-0.234(-0.90)-0.0492(-1.50)-0.00456(-1.95)-0.430*(-3.37)-0.393***

0.000

13.44

Yes

Yes

959

(2.14)

0.123**(0.78)

0.0445(1.67)

0.0193*(2.25)

0.00127**(1.05)

0.0699(-0.57)-0.03350.000

299.69

Yes

Yes

959

(-1.12)-1.211(-0.95)-1.229(3.63)

0.962***(-1.13)-0.0104(1.82)

2.498*(1.19)

1.323

0.000

273.94

Yes

Yes

959

(-1.15)-26.28(-1.00)-26.98(3.76)

21.60***(-1.25)-0.245(1.95)

57.44*(1.10)

25.32

3.099

Yes

Yes

959

(-0.62)-0.190(-2.22)-0.631**(-1.25)-0.109(-1.25)-0.00492(-1.37)-0.398(-2.29)-0.534**

2.628

Yes

Yes

959

(-0.57)-0.174(-2.99)-0.854***(-1.21)-0.103(-1.24)-0.00472(-1.38)-0.392(-2.06)-0.477**66

P-value
0.16410.15690.21240.2687
Note: This table presents instrumental variable regressions with industry and year fixed effects to confirm the destabilizing role of firm size. FOWN, FOWN*FSIZE, andNON_EX are treated as potentially endogenous variables. ∆lnBSIZEt-1 (the lag of the change in lnBSIZE), FOWNt-1 (the lag of foreign ownership), DIR_EXP (the average
working years of the directors in the company), DIR_AGE (the average age of the directors on board), and FOWNt-1*FSIZE are instrumental variables. The other variables aredefined as the same as in Table 4.3. The first-stage F test is used to test for the joint significance of the instruments. Hansen test for overidentifying restrictions is tested with
the null hypothesis that the excluded instruments are not correlated to the error term. Robust t-statistics adjusted for firm-level clustering are reported in parentheses. ***, **,and * denote significance at the 1%, 5%, and 10% levels, respectively.

Hansen J-statistics

Overidentification test of all instruments

14.75

F-statistics

F test of excluded instruments:

Yes

Year fixed

1092(-0.95)1092-1.020(2.35)(-0.75)(0.71)

0.136**-0.900(3.86)(2.22)

0.03800.796***(-1.55)(2.47)

0.0180**-0.0137(1.77)(1.15)

0.00129**

2.263*(1.69)(-0.63)0.0701

1.633*-0.0258

Observations

lnFAGE

LIQ

PB

STATE

lnBSIZE

ROE

4.5. Conclusion
Stock market liberalization has gradually become a global trend, forcing thegovernments in emerging markets to gradually remove restrictions on foreign ownership.
By allowing foreign investors to participate in the Vietnam stock market under Decision
No. 238/2005/QD-TT and relaxing foreign ownership rules to attract capital and support
local companies under Decree No. 60/2015/ND-CP, the Vietnam stock market has
witnessed a significant inflow of foreign investments. Therefore, investigating the impactof foreign ownership on stock return volatility in the Vietnam stock market contributes
to shedding light on the role and investment behavior of foreign ownership in the context
of an emerging market.
The corporate governance literature usually focuses on explaining the stabilizing
impact of foreign ownership but does not consider the association in relation to firm
characteristics. By using a sample of 160 companies listed in the Vietnam stock markets
in the period 2008-2017, the study shows a negative influence of foreign ownership on
stock return volatility, but notably, the calming impact of foreign ownership becomes
weaker in large firms. The findings are proved to be consistent when the study applies
instrumental variable regressions and uses the future one-year volatility as an alternative
measure of the dependent variable.
However, the study was limited to the detailed identification of foreign investors’
characteristics. It would, therefore, be interesting to investigate the impact of foreign
institutional ownership or large foreign shareholders’ ownership on the volatility inemerging markets. Such further studies could contribute to a more in-depth understandingof the role of foreign investors in the stability of the Vietnam stock market.
Finally, the findings also offer some implications of corporate governance in Vietnam
as well as in emerging countries. First, attracting foreign investors should be considered
as a risk control mechanism, but its effectiveness may depend on firm size. Second,
improving the regulations on corporate governance towards removing the restrictions on
foreign ownership is essential to enhance the quality of governance systems and risk
management. In brief, the effect of foreign ownership on stock return volatility in
Vietnamese listed companies will give more significant insights into the role of foreign
investors in emerging markets.

67

CHAPTER 5: CONCLUSIONS AND IMPLICATIONSThis final chapter provides a summary of the findings, implications, and limitationsof the dissertation and suggestions for future research. Section 1 summarizes the findings
in previous chapters. Section 2 provides several implications from the theoretical andpractical perspectives of the dissertation. Finally, section 3 points out some limitations of
the dissertation, and section 4 suggests areas of research in the future.
5.1 Summary of main findings
The dissertation assesses whether the presence of board independence and foreign
ownership is effective in controlling stock return volatility in Vietnamese listed firms.
Three central research questions have been addressed. The first question asks whether
increasing non-executive directors can reduce stock return volatility, especially inoverinvesting firms. The second question asks whether firms with more stock return
volatility increase or decrease non-executive director ratio, and how the regulationinfluences the association. The last question asks whether a high level of foreign
ownership can stabilize the fluctuations of stock return, especially in large-sized firms.
To address these questions, the dissertation employs a panel data sample ofVietnamese listed firm during the period from 2007 to 2017. Findings from thedissertation suggest: First, there are numerous challenges preventing non-executive
directors from implementing their supervising activities, which leads to information
asymmetries and stock return volatility. These challenges come from non-executive
directors themselves (limited perceptions of their roles), from corporate governancesystems (such as weak governance mechanisms, concentrated ownership and thedominance of the State). Gradually, they play as advisors other than supervisors. Despite
that, the risk management role of non-executive directors is not completely denied infirms with high risk or overinvestment. Second, increasing foreign ownership should beconsidered as an important mechanism to control stock return volatility, but its
effectiveness may depend on firm size.
5.2 Implications
5.2.1 About the role of non-executive directors in emerging market
Findings in this dissertation extend the literature on the roles of non-executive
directors by examining the relationship between non-executive director ratio and stock
return volatility in a transition economy. The study in the chapter 2 and 3 found that inVietnam, the inclusion of more non-executive directors does not benefit the monitoring
function. Instead, non-executive directors tend to place more emphasis on their advisory68role. However, the monitoring role of non-executive directors is improved in the case ofoverinvestment or high risk. Chapter 2 suggests that the presence of non-executive
directors in firms with more capital expenditures are likely to mitigate the volatility ofstock returns. Chapter 3 indicates that the need for non-executive directors starts toincrease again when firm risk reached a certain critical level. In other words, firms withtoo much capital expenditures or stock return volatility tend to urge non-executive
directors to increase supervision as well as to provide more links to external resources forminimizing risks. It indicates that non-executive directors can undertake both advisoryand supervisory functions at the same time, but their preference for a certain function may
be according to a particular circumstance in a different context. In transition economies,
where independent directors found it difficult to execute a monitoring function, theymight gradually shift their focus into an advisory function.
From an application standpoint, the results should recommend that the listed firms
take stock return volatility into consideration before they intend to nominate and appoint
non-executive directors into their board, especially in overinvesting or high-risk firms. It
is because adjusting board independence can play a significant role in pursuing a stableor risky business strategy. The findings also offer some implications of corporate
governance in Vietnam as well as in emerging countries. First, decisions on board
independence should be made after considering environmental and strategic factors.
Secondly, improving the regulations on corporate governance towards dispersedownership and management control is essential to enhance the quality of governancesystems and risk management. In brief, investigating the relationship between nonexecutive directors and stock return volatility will give more significant insights into therole of non-executive directors in Vietnamese listed companies and helps lawmakers
improve corporate governance legislations.
5.2.2 About the role of foreign ownership in emerging market
Chapter 4 offers some implications of corporate governance in Vietnam as well as inemerging countries. First, attracting foreign investors should be considered as a risk
control mechanism, but its effectiveness may depend on firm size. Second, improving theregulations on corporate governance towards removing the restrictions on foreign
ownership is essential to enhance the quality of governance systems and risk management.

69

5.3 Limitations of the dissertation
This dissertation has several limitations, as follows:First, although chapter 2 and chapter 3 focus on the relationship between nonexecutive directors and stock return volatility, the study cannot differentiate whether anon-executive director is nominated and appointed by controlling shareholders or
minority shareholders. Separating non-executive directors into 2 groups is important inassessing whether non-executive directors are representing the interests of minority
shareholders or they are under the control of controlling shareholders. If this study hasenough information on the nomination of non-executive directors, further analysis can be
conducted to explain the role of non-executive directors better. Besides, non-executive
directors’ specific characteristics such as demographics in terms of age, gender, andexperience; individual and representative ownership; their foreign ownership ratio; andso forth might also have an influence on their advisory or supervisory activities.
Second, the impact of large foreign ownership on stock return volatility has not been
investigated in chapter 4 because large foreign shareholders in the listed firms are usuallylarge financial institutions. Their behavior and investment strategy are appreciated to bedifferent from other foreign investors.
5.4 Further research
Because board independence has still been a new and under-explored area in
Vietnamese corporate governance system, investigating the effects of non-executive
directors’ specific characteristics such as demographics in terms of age, gender, andexperience; individual and representative ownership; their foreign ownership ratio; andso forth helps to better explain the behavior of non-executive directors in Vietnam.
Regarding foreign ownership, it has brought many benefits in stabilizing fluctuationsof stock returns, but the behavior of majority foreign shareholders should be deeply
investigated to bring a more detailed explanation about the behavior of foreign investors.
Apart from stock return volatility, future research may investigate the relationship of
non-executive directors and foreign ownership with other aspects of corporate activity
such as mergers and acquisitions, corporate policies such as debts or dividend policies,
investment efficiency.

70

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