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

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.