Examining pecking order versus trade‐off theories of capital structure: New evidence from Japanese firms

• Author: Ruhul Salim,Ali Salman Saleh,Shaif Jarallah
• Published date: 01 January 2019
• DOI: http://doi.org/10.1002/ijfe.1657
• Date: 01 January 2019

RESEARCH ARTICLE

Examining pecking order versus trade‐off theories of capital

structure: New evidence from Japanese firms

Shaif Jarallah

1

| Ali Salman Saleh

1

| Ruhul Salim

2

1

College of Business and Economics,

Qatar University, Doha, Qatar

2

Curtin Business School, Curtin

University, Bentley, Australia

Correspondence

Shaif Jarallah, College of Business and

Economics, Qatar University, Doha,

Qatar.

Email: shaif@qu.edu.qa

JEL Classification: G23; G32; C32

Abstract

This study empirically tests the traditional trade‐off model against the pecking

order model of capital structure using data from the Japanese listed companies

on the Tokyo Stock Exchange. A pooled sample of 1,362 publicly listed nonfi-

nancial companies from 1991 to 2015 is used to establish the relationship

between leverage and its determinants by using the generalized methods of

moments econometric framework. The results show that the financing pattern

of Japanese firms is consistent with the basic pecking order model, which pre-

dicts external debt financing driven by the internal financial deficit.

KEYWORDS

debt maturity structure, panel data analysis, pecking order theory, trade‐off theory

1|INTRODUCTION

Research on capital structure has focused on whether cor-

porate financing decisions matters or not. If financing

decisions were completely irrelevant, then actual capital

structures should vary randomly from firm to firm and

industry to industry. Nevertheless, this is not what is

being observed by empirical evidence in the field of cor-

porate finance. The current theory of capital structure

was established by Modigliani and Miller (1958). They

demonstrated that capital structure is irrelevant to the

value of the firm. The logic of the Modigliani and Miller

(1958) analysis is still accepted, despite the contradiction

of their theoretical conclusions with empirical evidence.

The reason is that they developed their theory based on

many assumptions. When these assumptions are relaxed

in order to bring the theory closer to reality, especially

when the taxes and the costs of financial distress are

not ignored, financing decisions do matter. This is why

the conditional capital structures theories came into

existence.

The contributions of this article to the current litera-

ture are as follows. First, this research focuses precisely

on the various predictions implied by the pecking order

theory and the trade‐off theory to analyse the financing

behaviour of the Japanese listed companies. This study

develops two empirical models to examine the relevance

of the two competing theories of capital structure by

using a unique large panel data for 1,362 publicly listed

firms on the Tokyo Stock Exchange (TSE) for the period

from 1991 to 2015. This allows for thorough investiga-

tions of the retrospective theories and their validity in

the Japanese market context. This is the first study to

incorporate such a comprehensive and reliable dataset,

the Nikkei Economic Electronic Databank System data-

base. The above period was chosen because it covers

many recent rapid changes in financial policies, regula-

tions, and reforms. It is, therefore, of immense interest

to explore how far this leads to different financial deci-

sions preferred by Japanese companies. Additionally, this

study uses the size of the company, profitability, divi-

dends payout ratio (DPR), and growth opportunities as

the variables to investigate the relative potency and

explanatory power of the pecking order theory and the

trade‐off theory.

The aim of the study is to identify empirically the fac-

tors that determine the optimal debt level in the Japanese

financial market. The finding based on the Japanese

Received: 19 February 2018 Revised: 21 August 2018 Accepted: 9 September 2018

DOI: 10.1002/ijfe.1657

204 © 2018 John Wiley & Sons, Ltd. Int J Fin Econ. 2019;24:204–211.wileyonlinelibrary.com/journal/ijfe