Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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80 The Elements of Capital Structure

Frank and Goyal (2003) test pecking order theory of corporate leverage. Contrary to

the theory, they find that net equity issues track the financing deficit more closely

than do net debt issues. Debt financing does not dominate equity financing in

magnitude. They conclude that equity is more important than debt.

Graham and Harvey (2001) find mixed results in their survey of 392 chief

financial officers (CFOs) in testing the pecking order theory and very little evidence

that executives are concerned about asymmetric information. Similarly, in their

study on capital structure decisions of Dutch companies, De Jong and Veld (2001)

do not find their results supporting the adverse selection costs of Myers and Majluf

(1984). Agca and Mozumdar (2005) argue that the conflicting evidence of pecking

order theory is more due to the differences between the financing practices of large

and small firms, and the skewness of the firm size distribution. The authors find

that the theory does not hold for small firms due to their low debt capacities that

are quickly exhausted, forcing them to issue equity.

Agency Costs Theory

The models based on agency costs focus on how capital structures can help con-

tain the agency costs by aligning the interests of the shareholders, managers, and

debt holders. Jensen and Meckling (1976) identify two types of conflicts: conflicts

between equity shareholders and managers, ...