The Society for Financial Research

Testing Trade-Off and Pecking Order Forecasts about Payouts and Financial debt Author(s): Eugene F. Celebridad and Kenneth R. People from france Reviewed work(s): Source: Delete word Financial Research, Vol. 15, No . you (Spring, 2002), pp. 1-33 Published simply by: Oxford College or university Press. Recruit: The World for Financial Studies. Stable URL: http://www.jstor.org/stable/2696797. Accessed: 16/02/2012 01: twenty eight Your usage of the JSTOR archive signifies your acknowledgement of the Conditions & Circumstances of Use, offered by. http://www.jstor.org/page/info/about/policies/terms.jsp JSTOR is a not-for-profit service in order to scholars, researchers, and college students discover, employ, and build upon a wide range of articles in a reliable digital store. We employ information technology and tools to improve productivity and facilitate new forms of scholarship grant. For more information regarding JSTOR, make sure you contact [email protected] org.

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Testing Trade-Off and Pecking Order Predictions About Dividends and Debt Eugene F. Reputacion University of Chicago Kenneth R. People from france Dartmouth College or university

Confirmingpredictionssharedby the trade-offand pecking ordermodels, even more profitable firms and businesses with fewer investments have got higher dividend payouts. Confirmingthe pecking ordermodel but contradictingthe trade-offmodel, more profitablefirms are much less levered. Businesses with more investmentshave less marketleverage, which is consistent with the trade-off model and a complex pecking buy model. Firms with more investments have reduced long-termdividendpayouts, although dividendsdo not vary to accommodateshortterm variationin investment. While the pecking order unit predicts, short-termvariation in investmentand earnings is mostly absorbedby personal debt.

The fund literature presents two competitive models of funding decisions. In the trade-off version, firms recognize their optimum leverage by weighing the cost and benefits associated with an additional money of financial debt. The benefits of personal debt include, for example , the taxes deductibility interesting and the lowering of free earnings problems. The cost of financial debt include potential bankruptcy costs and organization conflicts between stockholders and bondholders. On the leverage optimum, the benefit of the very last dollar of debt only offsets the fee. The tradeoff model makes a similar conjecture about returns. Firms improve value by selecting the gross payout that equates the costs and great things about the last money of dividends. Myers (1984) develops an alternative solution theory known as the pecking order model of funding decisions. The pecking purchase arises in the event the costs of issuing fresh securities whelm other costs and benefits of dividends and debt. The financing costs that generate pecking order behavior are the transaction expenses associated with new issues and the costs that happen because of management's superior information about the firm's prospective customers and the benefit of their risky investments. Because of these costs, firms finance new assets first with retained revenue, then with safe financial debt, then with risky personal debt, and finally, underneath duress, with equity. As a result, variation in a firm's power

of and gratefully the Harvey editor). (the (the acknowledge comments JohnGraham referee) Campbell of 1101East to F. Graduate Schoolof Organization, Address University or college Chicago, correspondenceEugene Fama, ELLE 58thSt., Chicago, 60637, or perhaps e-mail: eugene. [email protected] uchicago. edu. Delete word Financial Studies Spring 2002 Vol. 15, No . 1, pp. 1-33

? 2002TheSocietyforFinancial Research

The Review of Financial Studies / v 15 n you 2002

can be driven not really by the trade-off model's costs and great things about debt, but rather by the business net money flows (cash earnings less investmentoutlays). All of us test the dividend and leverage predictions of the trade-off and pecking order models. Our menu is...

References: Fama, Elizabeth. F., mid 1970s, " The Empirical Human relationships between the Gross and Investment Decisions American Economic Assessment, 64, 304-318.

Fama, Elizabeth. F., and K. Ur. French, 2001, " Disappearing Dividends: Propensity to Pay?, " Log of Financial Economics, 60, 3-43.

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