Firms’ Debt-Equity Decisions When the Static Tradeoff Theory and the Pecking Order Theory Disagree

47 Pages Posted: 7 Aug 2009

See all articles by Abe de Jong

Abe de Jong

Rotterdam School of Management, Erasmus University; Monash University

Marno Verbeek

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM); Netspar

Patrick Verwijmeren

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE)

Date Written: August 4, 2009

Abstract

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

Suggested Citation

de Jong, Abe and Verbeek, Marno and Verwijmeren, Patrick, Firms’ Debt-Equity Decisions When the Static Tradeoff Theory and the Pecking Order Theory Disagree (August 4, 2009). Available at SSRN: https://ssrn.com/abstract=1444172 or http://dx.doi.org/10.2139/ssrn.1444172

Abe De Jong

Rotterdam School of Management, Erasmus University ( email )

P.O. Box 1738
Room T08-25
Rotterdam, 3000 DR
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HOME PAGE: http://https://www.rsm.nl/people/abe-de-jong/

Monash University ( email )

900 Dandenong Rd
Room H3-56
Caulfield East, Victoria 3145
Australia

HOME PAGE: http://https://research.monash.edu/en/persons/abe-de-jong

Marno Verbeek

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Room T09-53
3000 DR Rotterdam
Netherlands
+31 10 408 2790 (Phone)

HOME PAGE: http://www.rsm.nl/mverbeek

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Netspar

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Patrick Verwijmeren (Contact Author)

Erasmus University Rotterdam (EUR) - Erasmus School of Economics (ESE) ( email )

P.O. Box 1738
3000 DR Rotterdam, NL 3062 PA
Netherlands

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