Pecking Order Theory vs. Trade-Off Theory: How do financing decisions differ with firm size?

Abstract

This paper examines the capital structure decisions in Norwegian firms. Using a database containing extensive accounting data on Norwegian firms from 2006 to 2015, we test whether or not the pecking order theory and trade-off theory of capital structure can explain financing decisions. To investigate the effect of company size, we divide our sample into three groups: (1) Small non-listed firms, (2) non-listed firms that fulfil the equity requirement to be listed in Norway, and (3) listed firms. We find that smaller and non-listed firms show a greater tendency than listed firms to adjust leverage in accordance with the pecking order theory. For listed firms, we find that the trade-off theory is suitable for explaining financing decisions as they show adjustment towards a target debt-ratio.