Testing the Trade-off theory against the Pecking order theory: An empirical study of Brazilian firms

Banasko, Olaseni (2014) Testing the Trade-off theory against the Pecking order theory: An empirical study of Brazilian firms. [Dissertation (University of Nottingham only)] (Unpublished)

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This study tests the Trade-off theory against the Pecking order on a cross-sectional sample of firms listed on the Brazilian Sao Paolo Exchange. The study covers 1995 – 2013 using 161 Brazilian firm-year observations.

Recent decades have seen the literature examine the effect of corporate financing when Modigliani & Miller’s (1958) propositions are relaxed, as well as introducing factors that greater reflect the real world such as market frictions and imperfections such as taxes, financial distress and asymmetric information.

This research approach has generated mainly two influential but competing theories of capital structure, namely the Trade-off theory and the pecking order theory.

A vast majority of the empirical literature has tended to focus mainly on investigating the capital structure decisions of the major industrial economies, with the most being done on the United States. It is therefore extremely important to test these competing theories for separate countries, especially emerging economies, as the factors which may be attributable to one economy may not necessarily relate to that of another.

We employ a partial adjustment model in order to test the trade-off theory, while using the Traditional empirical pecking order model, where a firms financing deficit is the only explanatory variable to test the pecking order theory. These tests only give the results of the competing theories in isolation, so in order to test them simultaneously we utilise an augmented version of the partial adjustment model where the pecking order variable is added.

The dynamic nature of our paper led us to use more appropriate dynamic panel estimators as these are better able to estimate the speed of adjustment in the trade-off with less bias. To the best of our knowledge, this dynamic process has not been used in our context of Brazilian firms.

Overall we find that the Trade-off theory outperforms the pecking order, with relatively quick speeds of adjustment of approximately 0.5 or 50%.

Keywords: GMM, AHIV, Augmented partial adjustment

Item Type: Dissertation (University of Nottingham only)
Depositing User: EP, Services
Date Deposited: 11 Nov 2014 16:32
Last Modified: 08 Jan 2018 09:16
URI: http://eprints.nottingham.ac.uk/id/eprint/27504

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