Testing the Pecking Order Theory of Capital Structure

53 Pages Posted: 12 Dec 2000  

Murray Z. Frank

University of Minnesota

Vidhan K. Goyal

Hong Kong University of Science & Technology (HKUST) - Department of Finance

Date Written: December 7, 2000

Abstract

The pecking order theory of corporate leverage is tested against the static tradeoff theory of corporate leverage, using a broad cross-section of US firms over the period 1980-1998. A derivation of the conditional target adjustment framework is provided as a better empirical test of mean reversion. None of the predictions of the pecking order theory hold in the data. As predicted by the static tradeoff theory, robust evidence of mean reversion in leverage is found. This is true both unconditionally and conditionally on financial factors. Leverage is more persistent at lower levels than at higher levels. When debt matures, it is not replaced dollar for dollar by new debt and so leverage declines. Large firms increase their debt in order to support the payment of dividends. By contrast, small firms reduce their debt while they pay dividends.

Keywords: Pecking order theory, static tradeoff theory, capital structure, mean reversion.

JEL Classification: G32

Suggested Citation

Frank, Murray Z. and Goyal, Vidhan K., Testing the Pecking Order Theory of Capital Structure (December 7, 2000). EFA 0157: AFA 2001 New Orleans. Available at SSRN: https://ssrn.com/abstract=243138 or http://dx.doi.org/10.2139/ssrn.243138

Murray Z. Frank (Contact Author)

University of Minnesota ( email )

Carlson School of Management
321 19th Avenue South
Minneapolis, MN 55455
United States
612-625-5678 (Phone)

Vidhan K. Goyal

Hong Kong University of Science & Technology (HKUST) - Department of Finance ( email )

Clear Water Bay, Kowloon
Hong Kong
852-2358-7678 (Phone)
852-2358-1749 (Fax)

HOME PAGE: http://www.vidhangoyal.com

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