Event Title

Does the Presence of Information Asymmetry Cause Management to Prefer Debt Financing? An Empirical Test of the Pecking Order Theory of Capital Structure

Location

CSU Ballroom

Start Date

9-4-2012 1:00 PM

End Date

9-4-2012 2:30 PM

Student's Major

Economics

Student's College

Social and Behavioral Sciences

Mentor's Name

Ihsuan Li

Mentor's Department

Economics

Mentor's College

Social and Behavioral Sciences

Description

The first widely accepted study of the effect of capital structure on the value of a firm was published in 1958 by Franco Modigliani and Merton Miller. The conclusion of their research was that capital structure was irrelevant to the value of a firm. However if management is rational and acting on behalf of rational shareholders, why do firms continually adjust their capital structure? In 1984 Stewart C. Myers developed a new theory that looked at the problem in a different way. He proposed that management's more precise knowledge, relative to external shareholders, about the value of the firm created informational costs associated with the issuance of debt or equity to finance a proposed investment project. His major conclusion was that the preferred order of financing was: retained earnings, debt, and finally equity. Empirical tests of the theory have been performed and often reject his theory. The most recent study performed to test the theory was done using data ending in 1998. My research will contribute to the existing body of literature by adding a fresh look with more recent data. I test Pecking Order Theory on a broad cross-section of publicly traded American firms from 1998-2011 using OLS regressions. I expect the large firms will exhibit some aspects of pecking order behavior and firm's financing deficit is less important in explaining net debt issues overtime for all firm sizes. I expect that Pecking Order Theory while intuitively appealing will not be supported empirically.

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Apr 9th, 1:00 PM Apr 9th, 2:30 PM

Does the Presence of Information Asymmetry Cause Management to Prefer Debt Financing? An Empirical Test of the Pecking Order Theory of Capital Structure

CSU Ballroom

The first widely accepted study of the effect of capital structure on the value of a firm was published in 1958 by Franco Modigliani and Merton Miller. The conclusion of their research was that capital structure was irrelevant to the value of a firm. However if management is rational and acting on behalf of rational shareholders, why do firms continually adjust their capital structure? In 1984 Stewart C. Myers developed a new theory that looked at the problem in a different way. He proposed that management's more precise knowledge, relative to external shareholders, about the value of the firm created informational costs associated with the issuance of debt or equity to finance a proposed investment project. His major conclusion was that the preferred order of financing was: retained earnings, debt, and finally equity. Empirical tests of the theory have been performed and often reject his theory. The most recent study performed to test the theory was done using data ending in 1998. My research will contribute to the existing body of literature by adding a fresh look with more recent data. I test Pecking Order Theory on a broad cross-section of publicly traded American firms from 1998-2011 using OLS regressions. I expect the large firms will exhibit some aspects of pecking order behavior and firm's financing deficit is less important in explaining net debt issues overtime for all firm sizes. I expect that Pecking Order Theory while intuitively appealing will not be supported empirically.

Recommended Citation

Guthmiller, Benjamin. "Does the Presence of Information Asymmetry Cause Management to Prefer Debt Financing? An Empirical Test of the Pecking Order Theory of Capital Structure." Undergraduate Research Symposium, Mankato, MN, April 9, 2012.
http://cornerstone.lib.mnsu.edu/urs/2012/poster-session-B/6