Profitability and Debt Capital Decision: A Reconsideration of the Pecking Order Model

Abstract

This paper tests for the adherence of firms in third world nations to the pecking-order model (POM) indetermining their debt level. We developed two econometric models to query the pecking-order model (POM) asit applies to firms’ financing decision in emerging economies. Cross-sectional dataset was constructed from theannual reports of 45 non-financial companies quoted on the Nigerian stock exchange in the year 2007. Weemployed Binary Logistic regression and Ordinary least squares (OLS) estimation techniques to estimate ourmodels and to test the study hypotheses. Our results coherently reveal negative relationship between corporateprofitability and debt utilization, and corporate debt limit relates positively to firms’ tangibility and size. Ittherefore suggests that the pecking-order model (POM) applies to firms in third world nations as to firms indeveloped economies. Therefore, the possibility of a firm attaining an optimal capital structure remains a mirage.Because this study has made used of both proxy and dummy variables, the usual caveats therefore apply.Furthermore, the results are specific to only the sampled firms, thereby may lack generalizability to firmsoutside the sampled firms. Researchers are encouraged to further extend the suggestions of this study.

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