Testing the Pecking Order Theory of Capital Structure Among Kenyan Firms

Abstract

The main aim of this study was testing the Pecking Order Theory of capital structure among firms in Kenyan listed firms, with the Nairobi Securities Exchange, for the period 2011-2016. According to this theory, firms always prefer retained earnings first, followed by debt and finally equity as the last resort. To investigate this, the study used data from a sample of 37 firms across 8 sectors that consistently traded between 2011 and 2016. The study used a panel regression model to investigate the relationship between changes in debt and financial deficit. Through a fixed effect model on the pecking order model, the study found a very strong support for the pecking order theory among firms in Kenya. In addition, the study found a positive relation between changes in debt and investments and a negative relationship between changes and debt and financial cash flows. This meant that Kenyan firms that invest heavily are likely to borrow more, and those with enough cash flows are likely to borrow less. Overall, the findings of this study will be useful to financial managers, investors and financial market policymakers. The results will help them factor in the costs of information asymmetries associated with financing when making capital structure decisions. This in turn will help them minimize the costs of financing while at the same time maximizing the benefits of a well-balanced capital structure.