A Direct Test of the Pecking Order Hypothesis in an Australian Context
Working Paper ISBN NO. 0-7298-0251-5
Posted: 24 Mar 1997
Date Written: March 1996
Proponents of the existence of an optimum capital structure suggest that companies continue to employ debt until the marginal benefit of leverage equals its marginal cost. In contrast, advocates of the pecking order theory contend that observed capital structures reflect the relationship between internally available funds and investment requirements. This study applies the methodology originally advanced by Shyam-Sunder (1988) to a sample of forty-one Australian companies. Extreme versions of target adjustment and pecking order modes are formulated, and their ability to explain observed capital structure over 1978-1993 is examined. Additional tests are undertaken to determine the predictive ability of these models on a holdout sample obtained by partitioning the sample period in two unequal lengths. The results suggest that the pecking order theory explains capital structure change more accurately than simple target adjustment formulations.
JEL Classification: G32, G31
Suggested Citation: Suggested Citation