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360 Corporate Finance BRILLIANT’S

Evidence à‘mU
Tests of the pecking order theory have not n¡qH$J Am°S>©a ϶moar Ho$ narjU ¶h Xem©Zo ‘| ¶mo½¶
been able to show that it is of first-order Zht hwE h¢ {H$ ¶h EH$ g§ñWm Ho$ H¡${nQ>b ñQ´>³Ma Ho$
importance in determining a firm's capital
{ZYm©aU ‘| g~go ‘hÎdnyU© h¡& ¶Ú{n H$B© Am°Wg© Zo nm¶m h¡
structure. However, several authors have found
{H$ Hw$N> CXmhaU h¢ {OZ‘| ¶h dmñV{dH$Vm H$m EH$ AÀN>m
that there are instances where it is a good
approximation of reality. On the one hand, Fama AZw‘mZ h¡& EH$ Amoa ’$m‘m VWm ’«|$M {OS>mZ, J¡{bb VWm
and French, Zeidan, Galil and Shapir (2018) em{na (2018) {bIVo h¢ {H$ ~«mOrb ‘| {ZOr g§ñWmAm| Ho$
document that owners of private firms in Brazil ‘m{bH$ n¡qH$J Am°S>©a ϶moar H$m nmbZ H$aVo h¢ VWm ‘m¶g©
follow the pecking order theory and also Myers
and Shyam-Sunder find that some features of VWm í¶m‘ gw§Xa Zo ^r nm¶m h¡ {H$ S>mQ>m Ho$ Hw$N> JwU Q´>oS>-
the data are better explained by the pecking Am°’$ ϶moar H$s Anojm n¡qH$J Am°S>©a Ûmam AÀN>r Vah dU©Z
order than by the trade-off theory. Goyal and {H$¶o J¶o h¢& Jmo¶b VWm ’«|$H$ Zo Aݶ ~mVm| Ho$ gmW Xem©¶m
Frank show, among other things, that pecking {H$ n¡qH$J Am°S>©a ϶moar Ag’$b ahVr h¡ Ohm§ Bgo {gÕ
order theory fails where it should hold, namely
hmoZm Mm{hE AWm©V² N>moQ>r g§ñWmAm| Ho$ {bE Ohm§ B§’$m°‘}eZ
for small firms where information asymmetry
is presumably an important problem. E{g‘oQ´>r EH$ ‘hÎdnyU© g‘ñ¶m ‘mZr OmVr h¡&
Profitability and debt ratios bm^Xm¶H$Vm VWm S>oãQ> aoemo
The pecking order theory explains the n¡qH$J Am°S>©a ϶moar bm^Xm¶H$Vm VWm S>oãQ> aoemo Ho$
inverse relationship between profitability and ~rM {dnarV g§~§Y H$m dU©Z H$aVr h¡…
debt ratios:
1. Firms prefer internal financing. 1. g§ñWmE§ B§Q>Z©b ’$m¶Z|qgJ ng§X H$aVr h¢&
2. They adapt their target dividend payout 2. do CZHo$ {Zdoe Adgam| Ho$ {bE CZHo$ Q>mJ}Q> {S>{dS>|S>
ratios to their investment opportunities, noAmCQ> aoemo AnZmVr h¢ O~{H$ {S>{dS>|S²>g ‘| AMmZH$
while trying to avoid sudden changes in
dividends. n[adV©Zm| go ~MZo H$m à¶mg H$aVr h¢&
3. Sticky dividend policies, plus unpredi- 3. pñQ>H$s {S>{dS>|S> nm°{bgr Ho$ gmW bm^ VWm {Zdoe
ctable fluctuations in profits and inves- Adgam| ‘| AZno{jV CVma-M‹T>md H$m AW© h¡ {H$
tment opportunities, mean that internally
generated cash flow is sometimes more Am§V[aH$ ê$n go CËnÝZ H¡$e âbmo H$^r-H$^r H¡${nQ>b
than capital expenditures and at other E³gn|{S>Ma go A{YH$ hmoVm h¡ VWm {H$gr Aݶ
times less. If it is more, the firm pays off g‘¶ H$‘ hmoVm h¡& ¶{X ¶h A{YH$ hmoVm h¡ Vmo g§ñWm
the debt or invests in marketable secu- nhbo BgHo$ H¡$e ~¡b|g H$mo H$‘ H$aVr h¡ ¶m BgH$s
rities. If it is less, the firm first draws down
its cash balance or sells its marketable ‘mHo©$Q>o~b {g³¶mo[aQ>rO H$mo ~oMVr h¡ Z {H$ {S>{dS>|S²>g
securities, rather than reduce dividends. H$‘ H$aVr h¡&
4. If external financing is required, firms issue 4. ¶{X E³gQ>Z©b ’$m¶Z|qgJ Amdí¶H$ h¡ Vmo g§ñWmE§
the safest security first. That is, they start g~go gwa{jV {g³¶mo[aQ>r H$mo nhbo Omar H$aVr h¢&
with debt, then possibly hybrid securities AWm©V² do S>oãQ> go àma§^ H$aVr h¢ BgHo$ níMmV² g§^dV…
such as convertible bonds, then perhaps hmB{~«S> {g³¶mo[aQ>rO O¡go {H$ H§$d{Q>©~b ~m§S²>g BgHo$
equity as a last resort. In addition, issue níMmV² g§^dV… B{³dQ>r A§{V‘ ghmam hmoVm h¡& BgHo$