The Decision of Debt or Equity Financing

Abstract: Different approaches have been used to test capital structure theories empirically. In this paper the statement that Myers and Majluf (1984) discussed, that a low risk debt issue should affect the firm value less than a high risk equity issue, is explored and tested by applying an event study approach similar to the one Eckbo (1986) carried out on different kinds of debt issuances. There are also some important assumptions are tested for comparable reasons. A sample of all firms on the NYSE from the period January, 1 in 2007 to December, 31 in 2012 is used. The findings are that the Pecking Order Theory holds rather well when looking at a two-day event window from issuance announcements of debt and equity. The Traditional Trade-off Theory also holds, but only under the fairly rough assumption that specific firms have very different capital structure value adding-optima. Interestingly, it is found that the market reaction effect of an announcement is delayed by one day and only visible on the day after the announcement.