Is Negative Profitability-Leverage Relation the only Support for the Pecking Order Theory in Case of Pakistani Firms?

Attaullah Shah, Jasir Ilyas


Previous studies on capital structure in Pakistan have
reported evidence in support of the pecking order theory. However, this
evidence is largely based on testing one dimensional relationship
between leverage ratios and firms’ profitability. The objective of this
paper is to extensively test the pecking order theory in Pakistan with
well-known pecking order testing models. Specifically, we use a sample
of 321 firms listed on the Karachi Stock Exchange from 2000 to 2009 and
test pecking order theory with models suggested by Shyam-Sunder and
Myers, Frank and Goyal, Watson and Wilson, and Rajan and Zingales.
Results of these models indicate that there exits only weak evidence in
support of pecking order theory in Pakistan. However, strong support is
found for pecking order theory when leverage ratios are regressed on
profitability ratio, along with a set of control variables. This
discrepancy in the results of the two sets of models needs further
investigation, as well as care in interpreting the results of existing
studies on capital structure in Pakistan. Our results show robustness
even after controlling for possible profits understatements or weak
corporate governance practices. JEL Classification: G10, G21, G32
Keywords: Pecking Order Theory, Profitability-Leverage Relation,

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