Testing static tradeoff against pecking order models of capital structure

This paper tests traditional capital structure models against the alternati ve of a pecking order model of corporate financing. The basic pecking order model, which predicts external debt financing driven by the internal finan cial deficit, has much greater time-series explanatory power than a static tradeoff model, which predicts that each firm adjusts gradually toward an o ptimal debt ratio. We show that our tests have the power to reject the peck ing order against alternative tradeoff hypotheses. The statistical power of some usual tests of the tradeoff model is virtually nil. (C) 1999 Elsevier Science S.A. All rights reserved.