Journal of Economics and Finance

, Volume 39, Issue 4, pp 807–823 | Cite as

Capital structure choice, information asymmetry, and debt capacity: evidence from India

Article

Abstract

We examine the relevance of the pecking order theory of capital structure among emerging market firms in the light of their debt capacity concerns. We consider the financing choices of all public listed Indian firms during 1992 to 2011 for the empirical analysis. The estimated annual pecking order coefficients range from 0.23 to 0.56, rejecting the argument that sample firms follow the pecking order while making their financing choices. We find that the pecking order theory fares poorly among firms that face higher asymmetric information costs. It is found to be performing relatively better among firms without debt capacity concerns. We also report an improvement in the pecking order coefficient once the concave nature of the relationship between debt issuances and financial deficit is considered. However, the pecking order approach when nested in the conventional leverage regression model, adds abysmally small amount of explanatory power. Overall, we argue that the pecking order theory fails to explain sample firms’ financing choices.

Keywords

Pecking order theory Adverse selection costs Debt capacity 

JEL Classification

G32 

References

  1. Agca S, Mozumdar A (2004) Firm size, debt capacity and corporate financing choices. SSRN eLibraryGoogle Scholar
  2. Baker M, Wurgler J (2002) Market timing and capital structure. J Financ 57(1):1–32CrossRefGoogle Scholar
  3. Balasubramanian N, Black BS, Khanna V (2010) The relation between firm-level corporate governance and market value: a case study of India. Emerg Mark Rev 11(4):319–340CrossRefGoogle Scholar
  4. Bertrand M, Mehta P, Mullainathan S (2002) Ferreting out tunneling: an application to Indian business groups. Q J Econ 117(1):121–148CrossRefGoogle Scholar
  5. Bhaduri S (2002) Determinants of corporate borrowing: some evidence from the Indian corporate structure. J Econ Financ 26:200–215. doi:10.1007/BF02755986 CrossRefGoogle Scholar
  6. Booth L, Aivazian V, Demirguc-Kunt A, Maksimovic V (2001) Capital structures in developing countries. J Financ 56(1):87–130CrossRefGoogle Scholar
  7. Chirinko RS, Singha AR (2000) Testing static tradeoff against pecking order models of capital structure: a critical comment. J Financ Econ 58(3):417–425CrossRefGoogle Scholar
  8. Fama EF, French KR (2005) Financing decisions: who issues stock? J Financ Econ 76(3):549–582CrossRefGoogle Scholar
  9. Fischer EO, Heinkel R, Zechner J (1989) Dynamic capital structure choice: theory and tests. J Financ 44(1):19–40CrossRefGoogle Scholar
  10. Flannery MJ, Rangan KP (2006) Partial adjustment toward target capital structures. J Financ Econ 79(3):469–506CrossRefGoogle Scholar
  11. Frank MZ, Goyal VK (2003) Testing the pecking order theory of capital structure. J Financ Econ 67(2):217–248CrossRefGoogle Scholar
  12. Goldberg PK, Khandelwal AK, Pavcnik N, Topalova P (2010) Imported intermediate inputs and domestic product growth: evidence from India. Q J Econ 125(4):1727–1767CrossRefGoogle Scholar
  13. Gopalan R, Nanda V, Seru A (2007) Affliated firms and financial support: evidence from Indian business groups. J Financ Econ 86(3):759–795CrossRefGoogle Scholar
  14. Harris M, Raviv A (1991) The theory of capital structure. J Financ 46(1):297–355CrossRefGoogle Scholar
  15. Hovakimian A, Hovakimian G, Tehranian H (2004) Determinants of target capital structure: the case of dual debt and equity issues. J Financ Econ 71(3):517–540CrossRefGoogle Scholar
  16. Huang R, Ritter JR (2009) Testing theories of capital structure and estimating the speed of adjustment. J Financ Quant Anal 44(02):237–271CrossRefGoogle Scholar
  17. Kaplan SN, Zingales L (1997) Do investment-cash flow sensitivities provide useful measures of financing constraints? Q J Econ 112(1):169–215CrossRefGoogle Scholar
  18. Khanna T, Palepu K (2010) Winning in emerging markets: a road map for strategy and execution. Harvard business review pressGoogle Scholar
  19. Kraus A, Litzenberger RH (1973) A state-preference model of optimal financial leverage. J Financ 28(4):911–922CrossRefGoogle Scholar
  20. Lemmon ML, Zender JF (2010) Debt capacity and tests of capital structure theories. J Financ Quant Anal 45(05):1161–1187CrossRefGoogle Scholar
  21. Myers SC (1984) The capital structure puzzle. J Financ 39(3):575–592CrossRefGoogle Scholar
  22. Myers SC, Majluf NS (1984) Corporate financing and investment decisions when firms have information that investors do not have. J Financ Econ 13(2):187–221CrossRefGoogle Scholar
  23. Oztekin O, Flannery MJ (2012) Institutional determinants of capital structure adjustment speeds. J Financ Econ 103(1):88–112CrossRefGoogle Scholar
  24. Rajan RG, Zingales L (1995) What do we know about capital structure? Some evidence from international data. J Financ 50(5):1421–1460CrossRefGoogle Scholar
  25. Shyam-Sunder L, Myers SC (1999) Testing static tradeoff against pecking order models of capital structure. J Financ Econ 51(2):219–244CrossRefGoogle Scholar
  26. Singh A. (1995) Corporate financial patterns in industrializing economies: a comparative international study. International Finance Corporation—technical paper (2)Google Scholar
  27. Singh P, Kumar B (2012) Trade-off theory vs pecking order theory revisited: evidence from India. J Emerg Mark Finance 11(2):145–159CrossRefGoogle Scholar
  28. Stiglitz JE (1989) Financial markets and development. Oxf Rev Econ Policy 5(4):55–68CrossRefGoogle Scholar

Copyright information

© Springer Science+Business Media New York 2014

Authors and Affiliations

  1. 1.Institute for Financial Management and ResearchChennaiIndia
  2. 2.Indian Institute of Management TiruchirappalliTiruchirappalliIndia

Personalised recommendations