Pecking Order Theory Test of Firms Listed at East Africa Securities Exchanges

Abstract

For a long time, there has been debate on whether firms have a preferred hierarchy of financing structure. Indeed, pecking order theory argues in favour of a preferred hierarchy of financing decisions with the highest preference being to use internal financing or retained earnings first, then debt and lastly external equity or shares. While some scholars have supported the existence of that rigid structure, others have argued to the contrary. Empirical works have yielded mixed results on the same. This study therefore analysed the relationship between financial structures and financial performance of listed firms at the East Africa Securities Exchanges in an attempt to validate the pecking order theory. The study employed explanatory research design with secondary panel data from the financial statements of 61 firms retrieved from the securities exchanges hand books for the period December 2006-2014. Descriptive statistics, Feasible Generalized Least Squares method, random effect for models without moderator and fixed effect for models with moderator, based on Hausman specification test were used. The study found out there is no preferred hierarchy and that various markets had their own preferred choices. As to the relationship between financial structure and return on assets or return on equity amongst securities exchanges, the study revealed that such relationships are different. It is therefore recommended that firms should use shareholders’ funds as much as practical before they result to borrowing. Firms should also look at and evaluate the political, economic, social and technological environment within their markets together with their internal environment ranging from opportunities available, management potential and industry threats among others, before making decision on the mode of raising finance.

Keywords: Financial performance, financial structure, pecking order