Testing the validity of capital structure theories using the partial adjustment method: Evidence from Philippine firms from 2005-2009

This paper investigates the applicability of capital structure theories such as tradeoff, pecking order, and maket timing using Philippine publicly listed firms from 2005-2009. The tradeoff theory suggests that firms adjust their leverage levels in an attempt to meet its optimal leverage ratio. On the other hand, the pecking order and market timing theories do not support targeting behavior. Rather, these theories claim that financing is dependent on the cost of sourcing the needed funds and prevailing market conditions. The study employed the partial adjustment method, taking into account deviations from target leverage ratios due to adjustment costs under the assumption of the tradeoff theory. The firms\u27 financing deficit and external finance weighted average market-to-book ratio are added to the model to test for pecking order and market timing behavior, respectively. Results reveal that the financing behavior of Philippine firms follows the pecking order theory. A firm\u27s financing deficit most likely explains its issuance of new debt. Optimal capital structures and market timing behavior appear to be secondary to a firms\u27 needs. Yet, industry specific regressions provided more varied results and show some evidence for tradeoff and market timing