Are trade-off and pecking order theories mutually exclusive in explaining capital structure decisions?

Abstract

In this study, using various panel models and estimators, we find empirically that the trade- off and
pecking order theories are not mutually exclusive in explaining quoted Portuguese companies capital
structure decisions. However, the finance behaviour of quoted Portuguese companies comes close to
that forecast by the pecking order theory: (i) the magnitude of the effects of financial deficit on debt is
clearly greater than the magnitude of the adjustment of actual level of debt towards optimal level of
debt; and (ii) information asymmetry seems to have special emphasis in companies’ capital structure
decisions. On the contrary, the attempt for a trade-off between debt tax shields and bankruptcy costs
seems to have little relevance in explaining the capital structure of quoted Portuguese companies. The
results also suggest that the preference of quoted Portuguese companies is for internal funds rather
than debt. However, when internal funds are insufficient, companies use debt to finance high growth
opportunities and the need associated with dividends payment.