Pecking order theory, trade-off theory and determinants of capital structure : empirical evidence from Jordan

Abstract

The theoretical framework of the pecking order and trade-off theories of capital structure has suggested the potential for exhibiting asymmetrical financing behaviour for firms with leverage below or above the target level of leverage or for firms with financial surplus or deficit. Such analyses shed light on how firms choose their capital structure under pecking order and trade-off theories and mainly when they have leverage target with leverage above-or below-target leverage or surplus or deficit. However, a lack of empirical studies on these issues can be noted in both developed and developing countries. This thesis examines a variety of pecking order and trade-off asymmetric models and compares their performance with the symmetric alternative. Using data from 114 non-financial Jordanian firms (of which 62 are industrial firms and the remaining are services firms), we report evidence suggesting that firstly, equity issues track the financing deficit relatively more closely, suggesting that equity is not the last resort for financing as the pecking order theory predicts Secondly, Jordanian firms are more sensitive in retiring debt to take up surplus than in expanding debt to meet their financing requirement, implying that financial surplus and deficit affect leverage differently. Thirdly, Jordanian firms have a target leverage ratio and adjust their leverage at rate higher for above-target leverage than for below-target leverage and at rate higher for firms with financial surplus than those with financial deficit. Finally, we report evidence suggesting that the rates of adjustment vary depending on whether the deviation from the target level is large or small, with rates higher for large size deviation than for small size deviation.