Firms’ Debt-Equity Decisions When the Static Tradeoff Theory and the Pecking Order Theory Disagree
47 Pages Posted: 7 Aug 2009
Date Written: August 4, 2009
This paper tests the static tradeoff theory against the pecking order theory. We focus on an important difference in prediction: the static tradeoff theory argues that a firm increases leverage until it reaches its target debt ratio, while the pecking order yields debt issuance until the debt capacity is reached. For a sample of U.S. firms in the period 1985-2005, we find that the pecking order theory is a better descriptor of firms’ issue decisions than the static tradeoff theory. In contrast, when we focus on repurchase decisions we find that the static tradeoff theory is a stronger predictor of firms’ capital structure decisions.
Keywords: Capital structure, pecking order theory, static tradeoff theory, debt capacity
JEL Classification: G32
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