Preferences, sources, and conditionals: a new approach to testing financing decisions

Abstract

This article aims to propose a new approach to the empirical testing of the pecking order theory that tackles commonly reported issues and apply it to the analysis of Brazilian companies. The main gaps bridged herein are the lack of clear definitions for safe debt and financial slack; the lack of control, in regressions, for the financing sources’ capabilities; and the failure to consider future investment opportunities in financing analyses. We adopt methods that enable controlling for the information the companies have about each financing source’s capabilities, at the time their financing decisions are made, while taking current and future investment opportunities into account. The proposed methodology offers a rather controlled environment to test the pecking order theory, which can be adapted to study other topics in finance, supporting advances in understanding the raising and allocation of funds by listed companies. Four integrated financing and cash holding policies are defined, which lead to different expected internal deficits (or surpluses). The relationships between these deficits (or surpluses), at different levels, and the flows that are observed at the external sources of funds are analyzed in cross-section and panel data quantile regressions, controlling for each source’s capabilities, in unbalanced data panels with 4,465 observations of 223 companies. By studying the relationships between expected internal financing deficits (or surpluses) and the flows that are observed at the external sources of funds, we contribute with a new capital structure testing methodology, and we find strong evidence that Brazilian listed companies follow the pecking order theory.

Analysis of the capital structure of startups in light of the tradeoff and pecking Order theories

“…The capital structure of startups is influenced by the particular environment in which they are inserted (information asymmetry, risks, growth potential, etc. ), and our results show that the order of preference for financial capital is different from that commonly investigated in traditional companies (Bastos et al, 2009;Iglesias et al, 2021;Rocha & Camargos, 2023). Our results also were different from the order indicated by Coleman and Robb (2012) and Robb and Robinson (2014), showing market differences between Brazil and the USA.…”

“…In Brazil, the pecking order theory has been found to best explain the capital structure of large companies. These works include Bastos, et al (2009), Correa et al (2013), Iglesias et al (2021) and Rocha and Camargos (2023). However, when it comes to startups, this is still an open question in the literature.…”

“…Previous studies have focused on analyzing the theory that best explains the capital structure of companies. Specifically in Brazil, Bastos, Nakamura and Basso (2009), Correa, Basso and Nakamura (2013), Iglesias et al (2021) and Rocha and Camargos (2023) investigated which of the theories (tradeoff or pecking order) explain the capital structure of established companies. However, when it comes to startups, this is still an open question.…”