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

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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.

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Notes

  1. Kraus and Litzenberger (1973) present classical trade-off theory. For dynamic version of the same refer to Fischer et al. (1989).

  2. Source: Indian Securities Market, A Review – Volume – 15, 2012. It is published by National Stock Exchange and available at http://www.nseindia.com/research/dynaContent/ismr.htm

  3. These are financial agencies (both state sponsored and privately managed) that provide medium and long term financing assistance and engage in promotion and development of industry and other key sectors.

  4. Flannery and Rangan (2006) reports market debt ratio for a typical US firm as 0.2783.

  5. We estimate β PO for each year across the study period 1993–2011. We lose 1 year (1992) data in constructing required variables.

  6. The small firms, here refer to the small firms in the context of the current sample firms, they may not be the small among the population of Indian firms.

  7. Frank and Goyal (2003) report β PO as 0.164 for small firms and 0.753 for large firms during the study period 1971 to 1989.

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Authors and Affiliations

  1. Institute for Financial Management and Research, 24, Kothari road, Nungambakkam, Chennai, 600 034, India

    Surenderrao Komera

  2. Indian Institute of Management Tiruchirappalli, Tiruchirappalli, 620 015, Tamilnadu, India

    Jijo Lukose P.J.

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  1. Surenderrao Komera
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  2. Jijo Lukose P.J.
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Correspondence to Surenderrao Komera.

Appendix

Appendix

Fig. 3
figure 3

Pecking order slope coefficients. Figure plots pecking order slope coefficients estimated annually using both Eqs. 1 and 2. Equation 1 is the basic pecking order test and the resulting estimates are plotted using dotted line. Equation 2 is the pecking order test augmented with quadratic term, square of financial deficit variable; and its findings are plotted using solid line. All the annual slope coefficients are found to be significant at 1 % level. Variables included in the analysis are winsorized at 1 and 99th percentile

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Komera, S., Lukose P.J., J. Capital structure choice, information asymmetry, and debt capacity: evidence from India. J Econ Finan 39, 807–823 (2015). https://doi.org/10.1007/s12197-014-9285-3

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