After critiquing arguments and evidence associated with the trade-off theory, the pecking order model, and the market timing hypothesis of corporate financing behavior, we develop a financing orientation hypothesis that integrates arguments from all three theories. The hypothesis posits that a firm's optimal leverage and its propensity to use debt to offset a current financing imbalance (i.e., the basic pecking order coefficient) are both largely driven by (i.e., are strongly inversely related to) the value of the firm's profitable investment opportunities. We test the hypothesis using data on U.S. firms for the years 1971-2009. The evidence is strongly consistent with the hypothesis, and resolves several puzzles lingering from previous empirical studies of the individual theories.
Shanhong Wu, Joseph P. Ogden
American Finance Association Meetings (AFA)