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THE TRADE-OFF THEORY AND THE PECKING ORDER THEORY: ARE THEY MUTUALLY EXCLUSIVE?

Carmen Cotei

University of Hartford, USA

 

Joseph Farhat

Central Connecticut State University, USA

 

ABSTRACT

The main purpose of this study is to simultaneously examine the pecking order and trade-off theories of capital structure and determine which one performs better for a sample of US firms. Our empirical models, which allow the financing coefficient and the rate of adjustment to vary with the firms' characteristics, provide evidence that the trade-off theory factors play a significant role in determining the proportion of debt to be issued or repurchased under the pecking order assumptions. In addition, we find that the pecking order factors are major determinants of the rate of adjustment under the trade-off theory assumptions. These empirical results imply that the pecking order theory and the trade-off theory are not mutually exclusive.

Keywords: capital structure; pecking order theory; trade-off theory

JEL Codes: G00, G10