Testing trade - off theory vs pecking order theory - evidence from Kenyan listed firms

Abstract

This study seeks to test both the pecking order theory and the trade-off theory theories using evidence from companies listed in the Nairobi securities exchange and examine which theory best explains capital structures of listed firms in Kenya. This research follows an investigative research design as it seeks to test the application of pecking order theory vs the trade-off theory is the context of listed firms in Kenya. Through random sampling, 30 listed companies were randomly selected for study representing 50% of the listed companies in Kenya. Listed firms are found to make a considerable adjustment towards the optimal debt ratio. However, there was an average negative speed of adjustment suggesting that some listed firms they are moving further away from the optimal debt ratio. Based on the sampled listed companies, using the LSDVC dynamic estimator as method of estimation, this study has clearly shown that the listed firms make an adjustment of their actual debt towards the optimal level of debt and age of the firms contribute to increase firm debt. More profitable and older companies have tended to use the pecking order theory. Limitations and disadvantages faced in this study is the fact that it only focused on determinants of general debt. Debt can be separated as long term and short term debt and may imply different levels of adjustment. Therefore recommend future studies and research to analyze how these determinants of debt may affect long term debt and short term and if there is difference in their adjustment rates