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Testing Of Pecking Order Theory In Pakistan

3401 words - 14 pages

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 ...view middle of the document...

The trade-off theory explains moderate, cautious borrowing. The Pecking Order Model was developed by Myers and Majluf (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 issued, and when it is not sensible to issue any more debt, equity is issued as last resort. There are two forms of pecking order theory one is strong form and other is weak form. 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 Due to Asymmetry of information “informational effect” the organization changes there behaviors toward capital structuring positive investment opportunities should be financed through available financial slacks or by debt financing is more valuable mix of capital structuring (Myers C.S et al 1984). Support sticky dividend policies to generate funds internally able to finance investment opportunities. This theory maintains that businesses hold to a hierarchy of financing sources and prefer internal financing when available, and debt is preferred over equity if external financing is required. According pecking order firm have not well defined optimal debt ratio due to asymmetric information firm adopt hierarchal order of financing preference the first priority internal financing if firms needed external financing by safe debt, risky debt equity financing is only used as lost resort Myers C.S et al 1984.
Every small, large corporation invests to maximize the value of their firm and try to design capital structure that overcome hurdles toward the value maximization.
This paper aimed at testing this theory on empirical grounds based on a sample of listed Pakistani firms. To achieve this goal, we used accounting data extracted from audited financial statements. The methodology utilized is similar to that employed by Shyam-Sunder and Myers (1999) and Frank and Goyal (2003). The sample congregates data of 286 firms 2001 to 2008. Within the Pakistani scenario, there are several studies for investigating if different capital structure theories replicates in Pakistan the same results obtained in countries with more developed economies and markets, especially the US and some European countries. However, such studies either do not specifically test the Pecking Order in Pakistan or do not use a methodology comparable to the one utilize here.
After vast discussion optimal capital structure still under conversation exploration toward the finalization still exist under both theories of capital structure. The remaining parts of the paper are as follows: Section 2 presents a literature review; Section 3 describes the data, the methods utilized; Section 4 analyzes the results obtained; Section 5 presents the conclusions; and Section 6 describes the recommendation; and section 7 describes...

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