Testing Static Trade-Off Against Pecking Order Models of Capital Structure
Posted: 4 Oct 1999
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 (author's emphasis) financing driven by the internal financial deficit, has much greater explanatory power than a static trade-off model which predicts that each firm adjust 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.
JEL Classification: G31, G32
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