This paper tests the static tradeoff theory against the pecking order theory. We focus on an important difference in prediction: the static tradeoff theory argues that a firm increases leverage until it reaches its target debt ratio, while the pecking order yields debt issuance until the debt capacity is reached. We find that for our sample of US firms the pecking order theory is a better descriptor of firms’ issue decisions than the static tradeoff theory. In contrast, when we focus on repurchase decisions we find that the static tradeoff theory is a stronger predictor of firms’ capital structure decisions.

Additional Metadata
Keywords capital structure, debt capacity, peckinng order theory, static trade off theory
JEL Financing Policy; Capital and Ownership Structure (jel G32)
Persistent URL dx.doi.org/10.1016/j.jbankfin.2010.10.006, hdl.handle.net/1765/21278
Series ERIM Top-Core Articles
Journal Journal of Banking & Finance
Citation
de Jong, A, Verbeek, M.J.C.M, & Verwijmeren, P. (2011). Firms’ debt–equity decisions when the static tradeoff theory and the pecking order theory disagree. Journal of Banking & Finance, 35(5), 1303–1314. doi:10.1016/j.jbankfin.2010.10.006