Abstract
In corporate finance, the pecking-order theory suggests that companies adhere to a particular financing hierarchy, with internal funding taking preference over external funding, and debt financing taking preference over equity. This paper examines whether South African state-owned entities prioritize their financing sources as predicted by the pecking-order theory. A financing deficit variable comprising various cash flow-based components was used to test the theory. A panel regression model was employed using panel data estimators. Using a cross-section sample of 33 state-owned entities from 1995 to 2018, the study finds no evidence that South African state-owned entities follow a pecking order to finance investment projects. The pecking order theory proposition that costs of adverse selection are dominant for lower levels of leverage provides a reason for the financing deficit coefficient not being close to unity and hence an indication that the SOEs in South Africa do not follow the pecking order behavior in their financing decisions, an indication that South African capital market is still developing.
Highlights
The pecking-order theory (POT) suggests that companies follow a particular financing hierarchy, where internal financing is preferred over external financing, and debt financing is preferred over equity (Myers, 1984)
The pecking order theory proposition that costs of adverse selection are dominant for lower levels of leverage provides a reason for the financing deficit coefficient not being close to unity and an indication that the State-owned entities (SOEs) in South Africa do not follow the pecking order behavior in their financing decisions, an indication that South African capital market is still developing
The results indicate that the financing deficit will minimize changes in net debt, since SOEs would cover the deficit with other sources of finance, including capital
Summary
The pecking-order theory (POT) suggests that companies follow a particular financing hierarchy, where internal financing is preferred over external financing, and debt financing is preferred over equity (Myers, 1984). Under the POT, companies do not have an optimum debt level for the reason that equity exists at both the top (internal equity) and bottom (external equity) of the pecking order In an emerging economy such as South Africa, these include reducing unemployment, inequality and poverty.
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