Pecking order or trade-off hypothesis? Evidence on the capital structure of Chinese companies

This study tests the pecking order and trade-off hypotheses of corporate financing decisions using a cross-section of the largest Chinese listed companies. The study is built on Allen (1993 Allen, DE. 1993. The pecking order hypothesis: Australian evidence. Applied Financial Economics, 3: 101–12. [Taylor & Francis Online] , [Google Scholar]), Baskin (1989 Baskin, JB. 1989. An empirical investigation of the pecking order hypothesis. Financial Management, 18: 26–35. [Crossref], [Web of Science ®] , [Google Scholar]) and Adedeji (1998 Adedeji, A. 1998. Does the pecking order hypothesis explain the dividend payout ratios of firms in the UK?. Journal of Business Finance and Accounting, 25: 1127–55. [Crossref] , [Google Scholar]) to set up three models in which trade-off and pecking order theories give distinctively different predictions: (1) the determinants of leverage; (2) the relationship between leverage and dividends; and (3) the determinants of corporate investment. In model 1, a significant negative correlation is found between leverage and profitability; in model 2 a significant positive correlation between current leverage and past dividends is found. These results broadly support the pecking order hypothesis over trade-off theory. However, model 3 is inconclusive. Overall, the results provide tentative support for the pecking order hypothesis and demonstrate that a conventional model of corporate capital structure can explain the financing behaviour of Chinese companies.