Debt Capacity and Tests of Capital Structure Theories
44 Pages Posted: 17 Oct 2002
Date Written: September 10, 2002
The impact of debt capacity on recent tests of competing theories of capital structure is examined. Controlling for debt capacity, the pecking order appears to be a good description of the financing policies of a large sample of firms. The main results are first, that internally generated funds appear to be the preferred source of financing. Second, if external funds are required, in the absence of debt capacity concerns, debt appears to be preferred to equity and, when possible, debt capacity is "stockpiled." Demonstration of this preference also provides evidence directly contradictory to the tradeoff theory. Finally, we present evidence consistent with the hypothesis that asymmetric information and its attendant costs are the basis for the observed pecking order of financing choice.
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