PECKING ORDER or TRADE OFF HYPOTHESIS? EVIDENCE ON THE CAPITAL STUCTURE OF CINESE COMPANIES

PECKING ORDER or TRADE OFF HYPOTHESIS? EVIDENCE ON THE CAPITAL STUCTURE OF CINESE COMPANIES

INTRODUCTION
Ø How capital structure determine? There are two broad competing model:
àTrade-off theory: state value maximizing fir will pursue an optimal capital structure by consider marginal cost and benefit of each additional unit of financing and then choosing form of financing that equates these marginal cost and benefit
à Pecking order theory: based on the argument that asymmetric information creates a hierarchy of cost in the use of external financing which is broadly common to all firm.
“There is no unique optimal capital structure to which a firm, gravitates n the long run”
Ø There is conceptual differences between two theory and distinguish between two in practice is not easy.;
Fama and Frech (2002)à trade-off did better in one case, pecking order in the other.
Graham and Harvey (2001)à there was a little evidence that a asymmetric information was a factor in financial decision.
Prasad et al (2001a)à the evidence remain inconclusive
Ø Singh and Hamid (1992) and Singh (1995), determine that firm in developing economies rely more heavily on equity than on debt to finance growth than do their counterpart in the industrial economies
“It is difficult to distinguish between trade-off and pecking order models because many determining variables are relevant in both models.
Ø This paperà sample listed Chinese company àlimited to a cross section of China’s top 50 listed companies in 2002 à using data for 2002 and then for 2003 (although a small sample may attenuate the generality of the result compare with the finding of Huan and Song (2002) with their larger but earlier dataset)
Ø Reason why Chinese company:
o Almost unique position being both a developing and transition economy
o Most listed companies were formerly owned by the state.

HYPOTHESES
Fama and French (2002)à Many variables held to determine leverage are common to both theoryà difficult to ‘horse race’ between two regression to distinguish adequately between two theory à have very different implication for corporate behavior.
Ø Determinant of leverage: profitability, size and growth
Trade-off theory predict a positive relationship between leverage and profitability
Suggest a positive relationship between leverage and fir size
Suggest a negative relationship between leverage and growth rate
Pecking order, there will be a negative relationship between leverage and profitability
Suggest a negative relationship between leverage and firm size
Suggest a positive relationship between leverage and growth rate
Ø Leverage and dividend
Trade-off theory implying a negative or significant relationship between dividend and leverage
Pecking order concludes that a significant positive relationship between the past dividend rate and current leverage
Ø Corporate investment and financing
Trade-off theoryà investment negative relationship to dividend rateà profitability, size and past leverage in the model
Pecking orderànegative relation between investment and sizeà leverage should be negatively related to investment
DATA AND METHODOLOGY
Ø Why china??
o Transition from planned economy to market economy
o Continues to be characteristic by: fragmented capital market, fragile banking system, poorly specified property right and institutional uncertainly
o Relatively short operating history
o Have not accumulate much reputation
o Most listed companies were originally state-owned enterprises, and privatization
o Well-functioning and fully enforced accounting and auditing system has developed only gradually in China.
Ø Data + Methodology:
o China’s top 50 companies for the period 2001-2003
o Data were extracted from published account of non-financial companies listed on the Shanghai and Shenzen stock exchange
o 44 non-financial companies, 15 companies is manufacturing, and the rest in non-manufacturing
o Use two dataset: for 2002 and 2001 using 2002 annual report, for 2003 and 2002 using 2003 annual report à Cross-section regression for 2002 and 2003 were estimated separately.
o Variables used in the regressionà look at the table.1***
Other variables in the model mostly defined in the standard model, there two components:
à Measuring profitability (ROA)
à Dividend (DIVEQ)
o Descriptive statistic are shown in table 2
RESULT
**all state in article is a result**
CONCLUSSION
There are four main finding:
significant negative correlation between leverage and profitability
Significant positive correlation between current leverage and past dividend, although at a lower significant level
the investment model is found between the growth of investment and the rate of past dividend
there is some degree of stability in the parameter values as between 2002 and 2003, notwithstanding the accounting changes which took place between these two years
ACKNOWLEDGE