Dynamic Relationship between Debt and Cash flow in Pecking Order Theory: Evidence from Panel GMM

Abstract

The paper investigates the relationship between cash flow and debt for South African firms. The difference generalized method of moment results show cash flow has significance and negative relationship with debt. Similarly, the system generalized method of moment results show negative relationship between cash with debt. The results affirmed pecking order theory of corporate financing and it reveals the incidence of asymmetric information problem between the firm and its financiers. Besides, the results imply a need to further develop South African capital market in order to reduce information asymmetry costs associated with raising external finance. Moreover, evidence of trade-off theory is also presented in the results which suggest that the dynamic nature of firms’ capital structure decision deserves attention.

Keywords: Capital structure; debt ratio; cash flow; pecking order theory; panel GMM; South Africa