The Applicability of Pecking Order Theory in Kenyan Listed Firms

Abstract

The focus of this study was to test the applicability of pecking order theory in capital structure formation of Kenyan firms listed on Nairobi Securities Exchange over the period 2002-2009. The study begins by addressing the factors affecting the formation of capital structure to Kenyan firms. The determinants of capital structure are relevant in testing the applicability of pecking order theory. The pecking order theory is based on the idea of asymmetric information between managers and investors. Managers know more about the true value of the firm and the firm’s riskiness than less informed outside investors. Existing studies have produced conflicting evidence on applicability of the theories hence increasing the need to test the pecking order theory by using data from the emerging markets like Kenya. Significant gaps exist in finance literature as to whether the theory has any application on emerging markets like Kenya. Hence the objective of the study was to test the applicability of pecking order theory. The dependent variable for this study was gearing ratio while the independent variables were internal fund deficit and firm-specific factors like profitability, size, asset tangibility, non-tax shield and growth opportunities. Panel Data were obtained from financial tables of 30 firms processed in NSE and Multivariate Regression was used to analyze the data and test the hypotheses.  The study established that size, non-tax shield, profitability, growth and tangibility are determinants of capital structure as predicted by pecking order theory. The study however found evidence supporting applicability of weak form of pecking order theory on listed Kenyan firms. The results are consistent to previous studies in developed countries. The study recommends for improvement of the bond market in Kenya to increase the availability of long-term external source of funds and provide Kenyan firms with more alternative sources of finance.

Keywords: Pecking Order Theory, Gearing, Fund Deficit, Surplus, Capital Structure