Examining the theory of capital structure: signal factor hypothesis

Abstract

The aim of this study was to explore how various levels of information asymmetry affect the capital structure of listed companies in Taiwan and China. Regression results over the past few decades have indicated that the trade-off theory lacks explanatory power, bringing into question the accuracy of the static trade-off theory and the existence of an optimal capital structure. On the other hand, the financial decisions of companies do not always appear consistent with the pecking order theory. Building on the research of Chou et al. (2011), this study sought to verify the signal factor hypothesis, which combines the trade-off theory with the pecking order theory.This study was the first one to employ the panel KPSS test with sharp drifts, developed by Chang and Ranjbar (2012), as well as the Fourier function to verify that an optimal capital structure does exist for companies with more symmetric information, thereby establishing the trade-off theory. Firms with information asymmetry show adverse selection costs, which supports the pecking order theory and rejects the existence of an optimal capital structure.

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