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Testing capital structure theories using error correction models: evidence from the UK, France and Germany


  • Viet Anh Dang


We employ an error correction model of leverage to test the trade-off and pecking order theories of capital structure for firms in the UK, France and Germany. The error correction framework extends the partial adjustment model by explicitly modelling changes in target leverage and past deviations from such target as determinants of firms’ dynamic leverage adjustment process. We also augment our empirical models to test the pecking order theory. Using appropriate and advanced dynamic panel data methods, we find that UK, French and German firms adjust towards target leverage quickly in both the partial adjustment and error correction models, which is consistent with the trade-off theory. We further show that the trade-off theory explains these firms’ capital structure decisions better than the pecking order theory in the models nesting the two theories.

Suggested Citation

  • Viet Anh Dang, 2013. "Testing capital structure theories using error correction models: evidence from the UK, France and Germany," Applied Economics, Taylor & Francis Journals, vol. 45(2), pages 171-190, January.
  • Handle: RePEc:taf:applec:45:y:2013:i:2:p:171-190
    DOI: 10.1080/00036846.2011.597724

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    References listed on IDEAS

    1. Ali, Héla Hadj & Lecocq, Sébastien & Visser, Michael, 2010. "The Impact of Gurus: Parker Grades and en primeur Wine Prices," Journal of Wine Economics, Cambridge University Press, vol. 5(01), pages 22-39, March.
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    Cited by:

    1. Hanifa, Mohamed Hisham & Masih, Mansur & Bacha, Obiyathulla, 2014. "Testing Sukuk And Conventional Bond Offers Based On Corporate Financing Theories Using Partial Adjustment Models: Evidence From Malaysian Listed Firms," MPRA Paper 56953, University Library of Munich, Germany.
    2. Mohamed, Hisham Hanifa & Masih, Mansur & Bacha, Obiyathulla I., 2015. "Why do issuers issue Sukuk or conventional bond? Evidence from Malaysian listed firms using partial adjustment models," Pacific-Basin Finance Journal, Elsevier, vol. 34(C), pages 233-252.

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