Determination of Corporate Credit Ratings: Vietnamese Evidence

Abstract

The global economies have been experiencing a process of rapid financial integration and globalization since the 1980s. Consequently, individual economies are increasingly under the influences of a wide range of factors at home and abroad, which generate not only more opportunities for trade and investment but also more risks for domestic firms. The twentieth century witnessed numerous, and in many cases, spectacular corporate default and insolvency cases in both the developed and emerging economies. The credit rating agencies have been playing an increasingly important role in the risk monitoring and risk management system, but recently, they were under criticism for failures in various aspects. In the case of Vietnam, the transformation into an open economy since the 1990s has enhanced the development of the credit market and the commercial banking system. Credit-related activities are one of the most profitable and fastest-growing areas, but such activities face a rising level of challenges due to the increasingly open and competitive business and economic environment. Consequently, Vietnamese commercial banks invest an enormous amount of financial resources in improving credit quality measurement and risk management procedures. Although the State Bank of Vietnam, since 2002, has developed the Credit Information Centre (CIC) providing corporate credit ratings and financial information to support banking systems and other enterprise investors, the rating procedures of both Vietnamese commercial banks and the CIC are still at the early developmental stage. Moreover, there is little practical research concerning how and to what extent the corporate credit ratings of Vietnamese firms are affected by corporate, market, and macroeconomic conditions. Despite reservations about the quality of the credit ratings, the ratings by the CIC and the commercial banks in Vietnam are the only comprehensive measures of corporate credit ratings in Vietnam. Keeping this caveat in mind, the primary purpose of this study is to examine the impact that various organizational, financial, and macroeconomic variables have on credit ratings for Vietnamese corporations. By working closely with the CIC, a comprehensive dataset is constructed that contains the credit ratings for 500 Vietnamese firms and a wide range of potential determinants of corporate credit ratings over four years from 2011 to 2014. Considering the potential limitations in the dataset and given the general lack of relevant research in the Vietnamese context, a triangulation approach to the determination of credit ratings of Vietnamese firms is undertaken. The main task is to identify the main determinants of corporate credit ratings and estimate their impacts. The specification of the model is based on a comprehensive review of relevant literature and considers the credit rating determinants in four aspects, including firm-specific financial ratios, macroeconomic factors, earnings management practice, and capital structure. Following a series of tests, the model is estimated using GMM for an Arellano-Bond dynamic panel (or GMM-IV) model. The GMM-IV model is further complemented by other models that focus on how earnings management affects the impacts of financial ratios on credit ratings using the ordered-probit model and how macroeconomic and firm-specific factors determine credit rating transition into a financial distress status using the Cox hazard model. The key findings confirm the significance of a wide range of financial ratios for the determination of corporate credit ratings. However, the current financial ratios are limited for identifying those firms that are in financial distress, and various macroeconomic variables are additionally useful for examining the deterioration in corporate financial status. Earnings management practices break the link between key financial ratios and credit ratings and thus makes credit rating baseless. The research has contributed to the academic literature and rating practice in Vietnam. It provides a close analysis of several determinants that have significant impacts on Vietnamese corporations’ credit ratings but have not been explicitly explored in the rating process of the CIC. The research also proposes to Vietnamese commercial banks enhanced procedures for improving their credit analysis which is currently mainly based on qualitative methods.