Testing Static Trade-Off Against Pecking Order Models of Capital Structure
35 Pages Posted: 29 Jun 2000 Last revised: 13 Apr 2008
Date Written: April 1994
This paper tests traditional capital structure models against the alternative of a pecking order model of corporate financing. The basic pecking order model, which predicts external debt financing driven by the internal financial deficit, has much greater explanatory power than a static trade-off model which predicts that each firm adjusts toward an optimal debt ratio. We show that the power of some usual tests of the trade-off model is virtually nil. We question whether the available empirical evidence supports the notion of an optimal debt ratio.
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