Testing the pecking order theory of capital structure in South Africa

Abstract

This study was conducted with the aim of testing the pecking order hypothesis as well as examining the variables influencing the capital structure decisions using companies that are listed on the main board of the Johannesburg Stock Exchange over 12 years from 2009 to 2020. It has been noted that several listed companies in South Africa are facing the challenge of survival in the current economic climate. The companies are constantly found to be in risky situations in relation to their finances, which makes it difficult for them to meet their responsibilities to creditors and other stakeholders. Making the correct decisions regarding capital structure enhances the financial well-being of any organization. When companies fail to make the right capital decisions, the result can be financial distress, bankruptcy, and liquidation. The research will also inform both potential and existing investors in South Africa on the general approach to funding of the JSE listed companies and therefore give investors some basis for their investment decisions. A total of 197 companies excluding financial companies were selected to be used in the study using stratified random sampling. Pooled ordinary least squares, fixed effects and random effects models with heteroscedasticity robust standard errors were used. The results from the model employed to test the pecking order hypothesis do not show strong evidence of company management going in line with the pecking order theory when making decisions regarding the financing of the company. The conventional leverage regressions run to determine the factors that influence the capital structure were found to be consistent with theoretical predictions except for firm size which had the correct sign as predicted by theory but statistically insignificant. Asset tangibility and firm size were both positive while Market to Book and profitability were both negative in line with theoretical predictions. All the conventional predictors of leverage were statistically significant at the 1% and 5% significance levels except for firm size which was not statistically significant at any of the conventional levels of significance. Thus, for the sample of companies used in this study and the sample period selected, there is no strong support for the pecking order theory while leverage is determined by growth options as proxied by MTB, asset tangibility as well as profitability. A limitation of the model used in this study is that it only considered firm-specific factors in determining the predictors of leverage. Future research could include macroeconomic variables as additional predictors of the financing decisions of listed firms in South Africa as empirical evidence shows that these macroeconomic are important in the leverage-financing deficit nexus