Testing of Pecking Order Theory in Pakistan

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This study tests the Pecking Order Theory for the capital structure of listed firms in Pakistan. As per Pecking Order Theory in capital structure formulation internally generated resources would have first priority followed by debt issuance where as equity is used as last resort. In its strong form, the Pecking Order Theory sustains that equity issues would never occur, whereas in its weak form, limited amounts of issues are acceptable. The methodology adopted in this empirical study involves cross-section regressions and the testing of hypotheses stemming from the underlying theory in its strong and weak forms. The sample of capital structure of non financial firms from KSE is considered from for 2001 to 2008. The statistical tool of panel data regressions analysis is used to test different firm’s data. The value of R2, t-test and F-Stat indicate firm in KSE support weak form of pecking order theory i.e. the option of using internal equity and debt is more preferred and limited amount of external equity is used for reinvestment and fund raising purpose. Pakistani firms should straight away go for debt instead of external equity for fund raising purpose. 1-Introduction Capital structure refers to the way a corporation finances its assets through combination of equity, debt or hybrid securities. Many theories are available regarding capital structure formulation. Modigliani and Miller (1958, 1963) contribute an important work to capital structure also a number of researchers attempt to find factors to establish certain capital structure. Two important theories in capital structure are static trade-off theory and pecking order theory. In the static trade off model, firms determine their optimal leverage... ... middle of paper ... ...SN 1450-2887. Modigliani. F. and Miller. M.1958, “The Cost of Capital. Corporation Finance and the Theory of Investment”, The American Economic Review. Vol. 48. Raj Aggarwal and N. Aung Kyaw. January 2006, “Leverage, Investment Opportunities, and Firm Value: A Global Perspective on the Influence of Financial Development”. Shyam-Sander. L. and Myers. S.C.1999, “Testing static tradeoff against pecking order models of capital structure”, Journal of Financial Economics. Vol. 51. 219 – 244. 1999. Stewart C. Myers. 1984, “The Capital Structure Puzzle”, The Journal of Finance, Vol. 39, No. 3. Wolfgang Bessler, W. Drobetz,y and Matthias C. Gruninger. 2008, “International Tests of the Pecking Order Theory”. Xueping Wu. Zheng Wang.2004, “Equity financing in a Myers–Majluf framework with private benefits of control”, Journal of Corporate Finance 11 (2005) 915– 945. 22

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