Financial Flexibility and the Risk of Inadequate Interest Coverage: Evidence from Vietnamese Listed Firms

Abstract

Financial flexibility, often proxied by spare or unused debt capacity, is thought to help firms avoid difficulty servicing debt when earnings decline, but evidence directly linking a firm's history of low leverage to the subsequent onset of inadequate interest coverage remains limited, particularly in emerging markets such as Vietnam. This study examines whether persistent low leverage, used as a proxy for financial flexibility (FF), is associated with a lower likelihood that a Vietnamese listed firm transitions from adequate interest coverage, ICR(t) ≥ 1, to inadequate interest coverage, ICR(t+1) < 1, and whether this association carries incremental predictive information beyond the firm's current leverage. Using 3,416 firm-year observations from 579 non-financial firms listed on the Ho Chi Minh Stock Exchange and Hanoi Stock Exchange, including 323 transitions to inadequate coverage, the study estimates nested pooled logistic regressions with industry and year fixed effects. FF firms display a lower raw entry rate into inadequate coverage than non-FF firms, and persistent low leverage is negatively associated with the outcome in a preliminary specification; however, the association becomes smaller and statistically insignificant once current leverage is held constant, and sensitivity analyses across alternative coverage definitions, zero-interest-expense treatments, FF constructions, and fixed-effects specifications yield mixed results. The findings suggest that current leverage, rather than its multi-year history, is the more informative signal of near-term coverage risk, with implications for how researchers and practitioners construct and interpret financial-flexibility proxies among Vietnamese listed firms.