Testing Of Packing Order Theory In Case Of Pakistan

2733 words - 11 pages

(1) Introduction
There are three main capital structure theories which materialized from the reflections on the Modigliani and Miller (MM) Theorem (1958) first static tradeoff theory, Agency cost theory and Pecking order theory. This study is undertaken in Pakistan perspective.
The phenomena that developed by MM about market perfection under critics in gaze of mentioned theories.
The Pecking Order Model is component of capital structure was developed by Myers C.S et al 1984. It state that companies prioritize their source of financing in descending order (from retain earning to new stock ) internal funds are used first by retain earning, depreciation, and when that is used up, debt is ...view middle of the document...

(2) Literature review
In general packing order theory says that most of the firms follows a hierarchy ,when financing their projects, first finance by internal equity followed by debt issues, and finally by external equity . New stock is issued at last option. This hierarchical order is fundamental to the packing order theory. If a firm issue new stock at first place then packing order theory does not hold. The pecking order theory also implies that more profitable firms naturally prefer internal financing they would finance their new projects without issuing debt or equity financing through debt is better than equity financing due to asymmetry of informational effects disturb the value of firm as well existing share holder wealth attached with issuance of new stocks (Mayer,1984). According to Murray Frank and Goyal (2003) leverage is more constant at lower level than at higher level leverage on maturity of debt it’s not replaced by new debt leverage gone decline large firm increase their debts in order to support the payment of dividends by contrast small firms reduce their debts while they paying dividends. The study is taken on US firms in the period of 1985 to 2005 by Abe de jons, M.Verbeek and P. Verwijmeren (2008) found that pecking order theory is better descriptor of firms issues choice than static Trade off Theory in contrast when focuses on repurchase decisions study reveal that static tradeoff theory is stronger forecaster of firms capital structure decisions.
The study is taken on 6000 US and non US firms in the period of 1995 to 2005 by w. Bessler et al (2008) found that non US firms and civil law countries support packing order theory but the hierarchy of financing is agency cost rather than on adverse selection problem. Financing the project is not on the base of adversely selected but it is selected by taking consider the shareholder interest.
The study is taken on 132 non financial firms listed in Brazilian stock exchange by Daher et al. (2004) found that on one side it is very difficult to obtain credit and on the other side it is very difficult to issue new stock but in such situation the Brazilian firms goes for debt which makes the packing order theory to be supported by the Brazilian data.
The study is taken on 17000 firms 41 different foreign countries with non financial companies
By Abu Jalal (2007) found that due to information asymmetry and adverse selection costs firms always use debt financing rather using equity financing whenever they have financing needs. In developed countries like US they did not depend as much as firms of developing countries depend.
The impact of debt financing depends on the availability of investment opportunities in every country, either low growth firms or high growth firms accordingly agency costs differ across the countries due to dissimilar legal and financial structures (Raj Aggarwal et al 2006). Partial support exist Pecking order theory toward capital structuring neither...

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