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PECKING ORDER THEORY OF CAPITAL STRUCTURE AND GOVERNING

MECHANISM : EVIDENCE FROM INDONESIAN STOCK EXCHANGE

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 MALAYSIAN
ECONOMIC
ASSOCIATION

FACULTY OF In collaboration with

ECONOMICS
& ADMINSITRATION

THE 36TH FEDERATION OF ASEAN ECONOMIC

ASSOCIATIONS (FAEA) CONFERENCE

ASEAN AFTER THE GLOBAL CRISIS: MANAGEMENT

AND CHANGE

24-25 November 2011, Kuala Lumpur, Malaysia

Venue: CITITEL Hotel, (Mid Valley) , Kuala Lumpur

PECKING ORDER THEORY OF CAPITAL STRUCTURE AND

GOVERNING MECHANISM : EVIDENCE FROM INDONESIAN STOCK

EXCHANGE

Name of
Corresponding Dr. Tri Gunarsih, M.M.
Author
Title & Position
Lecturer, Vice Rector in Academic Affairs

Institution & Full UNIVERSITAS TEKNOLOGI YOGYAKARTA,

Postal Address Jalan Ringroad Utara, Jombor, Sleman, DIY, Indonesia.

E-mail Address gunarsih_t@yahoo.com

 PECKING ORDER THEORY OF CAPITAL STRUCTURE AND GOVERNING
MECHANISM : EVIDENCE FROM INDONESIAN STOCK EXCHANGE

Dr. Tri Gunarsih, M.M.

Bambang Hartadi, Ph.D.,M.M., CPA

University Technology Yogyakarta

Phone : 062-274-623310
Fax: 062-274-623306

Email: gunarsih_t@yahoo.com
bhartadi@yahoo.com

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 2
 PECKING ORDER THEORY OF CAPITAL STRUCTURE AND GOVERNING
MECHANISM : EVIDENCE FROM INDONESIAN STOCK EXCHANGE

Abstract
Numerous empirical studies in finance have tested many theories for firms’ capital
structure. The pecking order theory of capital structure is among the most influential theories
of firms’ capital structure. The first objective of this study is to test whether the listed
companies in Indonesian Stock Exchange (IDX) follow the Pecking Order Theory (POT).
The second objective of this study is to examine the impact of governing mechanism
(ownership structure) on pecking order theory of capital structure.
Samples in this study are companies listed in the IDX during 2001-2007. The
research questions are tested by running regression models as in Shyam-Sunder and Myers
(1999) and Cotei and Farhat (2008). This study extends the test of POT by examining the impact
of governing mechanism (ownership structure) on POT.
The first empirical result of this study shows that the listed companies in Indonesian
Stock Exchange do not follow POT. The second empirical result, show that POT is not
supported either. Other governing mechanism variables that statistically significant are the
number of board of director and the number of board of commissioners. This suggets that
both empirical research show that listed companies in Indonesian Stock Exchange do not
follow the POT.

Key words: pecking order theory, capital structure, governing mechanism

I. INTRODUCTION

Capital Structure refers to the way of corporations finance their assets through some
combination of equity, debt or preferred stock. Several theories and models try to explain
about the capital structure, including the trade-off theory and pecking order theory.
Empirically, the findings from testing theese theoryies are not consistent. Shyam-Sunder
and Myers (1999) provide empirical evidence that the findings further support the
pecking order theory than the trade-off theory. While Byoun and Rhim (2005) find
empirical evidence that both theories can explain the variation of corporate liabilities.
Another study conducted by Fama and French (2002) show evidence contrary to both
theories. Frank and Goyal (2003) in their research found evidence that is inconsistent
with the pecking order theory, especially in companies with small size. Some research
shows that the theory of capital structure has not been empirically shown consistently.
In this paper, we study the pecking order theory of capital structure of publicly traded
Indonesian companies. This study extends previous studies testing the pecking order
theory with data from Indonesia since the agency problems in the Indonesian Stock
Exchange is the divergence of interest between the minority holders and majority
holders. This is because the Indonesian Stock Exchange is characterized, among other
things, by the domination of large shareholders (Gunarsih, 2003), unlike another country

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 3
 that the main agency problems that occurred is between managers and company owners
(shareholders). Thus the structure of corporate governance in Indonesia is different from
other countries, such as the United States. Ownership structure of listed companies in
Indonesia is concentrated on a few owners while the ownership structure in the United
States is spreading to many owners with a relatively small proportion of ownership. In
the concentrated ownership structure, the main agency problem is the majority holder
with minority, while in the spread ownership, the main agency problem is between
managers with the owner.
Table 1 shows financial data of public companies in Indonesia. The data show that
the proportion of debt relative to total assets (Leverage) decrease while assets increase.
This suggests that leverage is not the main source of corporate financing. Another
financial data, net sales also increased, although in 2001 and 2002 has decreased
compared to the year 2000. One of the financial performance indicator, net profit after
tax (EAT) has a tendency to fluctuate despite increasing. These data indicate that the
company increased assets and financial performance, but not the leverage.

Table 1. Public company financial indicator (year 1999-2005, in million rupiah)

Earning
Tahun Assets Net Sales After Tax Leverage
1999 2,517,532.66 1,066,343.32 -70,147.44 0.805
2000 3,055,954.42 1,224,264.27 -146,025.88 0.825
2001 3,636,058.32 270,67 29,546.42 0.769
2002 3,519,551.09 3,527.86 135,834.38 0.709
2003 4,238,640.07 1,388,160.91 134,202.80 0.662
2004 4,668,207.96 1,621,984.75 164,008.94 0.620
2005 5,205,664.00 1,919,868.28 150,979.19 0.591
(Source: Indonesian Capital Market Directory, 2006)
It is interesting to explore furthur, whether these companies finance their assets
using internal sources of financing or external sources of financing. The first objective of
this study is to test whether the listed companies in Indonesian Stock Exchange follow
the pecking order theory. Pecking order theory was chosen because based on secondary
data, the trend of corporate debt relative to total assets (Leverage) decreases over time
(Table 1). This indicates that the company does not use debt to increase the value of its
assets because the asset value increases but the leverage is decreasing.
It is argued that unlike the agency problems advanced stock market, the agency
problems in the Indonesian Stock Exchange is the divergence of interest between the
minority holders and majority holders. This is because the Indonesian Stock Exchange is

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 4
 characterized, among other things, by the domination of large shareholders. The second
objective of this study is to examine the impact of governing mechanism (ownership
structure) on pecking order theory of capital structure.

II. LITERATURE REVIEW

A. Capital Structure

Capital structure is a combination (mix) the source of corporate funding that

comes from debt, preferred stock and common stock. Debt can increase the value of
corporate debt, but if the debt is too high then will increase the risk of the company.
One of the risks is default, the company failed to pay the debt and cost of capital that
will result in corporate bankruptcies.
Optimal capital structure is a combination of funding sources which consist of
debt and stock that will yield the highest value of the firm. One indication of the high
value of the company is high stock prices. Thus, the optimal capital structure is a
capital structure that generates the highest stock price. Another indication of an
optimal capital structure is lowest cost of capital weighted (Weighted Average Cost
of Capital - WACC). WACC is the combination cost of debt and capital stock that
calculated by weighted average.
One of the capital structure theories is Modigliani and Miller (MM). MM
explained that the companies that use debt will have higher firm value than firms that
do not use debt. The higher the debt of the company (higher the ratio of debt to
assets), the higher the value indicated by the value of company stock (Figure 1 on the
line MM Result). But in reality, the continuous increase in debt will not increase firm
value because it increases the risk of the company. The high debt will allow the risk
of default (the default). If this happens then it will lower the value of the company.
Actual conditions (Figure 1 actual line) are the firm value will increase with the
increase in debt (leverage) companies. Increased leverage will increase the value
companies until a certain level (Figure 1 second dotted line). Increased levels of
leverage after the rule will reduce the value of the company as a result of the
increased risk of corporate debt.
This theory provides a basis for managers in deciding the financial sources,
whether from debt or equity. The company will sell the shares if the stock is
overvalued (overvalued) and will issue debt if the stock is undervalued (undervalued).

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 5
 These conditions can be concluded that the issuance of shares is seen as a negative
signal by investors because, according to the manager, the company's stock
overvalued. Thus, companies with good prospects will avoid having to sell shares but
will use other instruments in the capital increase including the use of debt.
Conversely, companies with good prospects will not sell shares in obtaining
additional capital. This will result in the increase of new investors who will also bear
the losses due to the prospects are not good.

Value of Stock

Actual

No leverage

D/A

Figure 1. The value of shares and Leverage

B. Pecking Order Theory

Pecking order theory (Myers and Majluf (1984) and Myers (1984)) and the
extension of this theory (Lucas and McDonald, 1990) studied based on the
asymmetricic information between managers and investors. Managers have more
information about the true value of the enterprise and enterprise risk compared to
outside investors. According to Myers (1984), firms finance their activities with
retained earning when feasible. If the return earning are inadequate, then debt is used.
Only in extreme cases will firms use new equity finance. Thus, the order of financial
sources used was the source of internal funds from profits, short-term securities, debt,
preferred stock and common stock last. Pecking order theory predicts that the
issuance of equity (common stock) is the last alternative sources of funding.

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 6
 As described by Myers (1984), the pecking order theory suggests that firms
first prefer internal sources of finance, and they adjust their target dividend payout
ratio to their investment opportunities. If the firms seek external finance, due
togenerous dividend policies, unpredictable fluctuations in profitability or investment
opportunities, firms will choose debt (as the safest instrument), and then hybrid
securities such as convertible bonds, and then equity as a last resort. The pecking
order theory generally explains why firms might rationally let cash flows determine
leverage. This suggests that firms turn to debt funds under pressure of an internal
funds shortage.
Myers and Majluf (1984) argue that asymmetric information will lead to a
mis-pricing of a firm’s equity in the marketplace, causing a loss of wealth for existing
shareholders. Myers and Majluf (1984) claim that if the firm finances its new project
by issuing new securities, these securities will be under-priced. This is because
managers cannot credibly convey the quality of their existing assets and available
investment opportunities to potential investors. As a result, outsiders may not be able
to discriminate between good and bad projects, consequently interpreting the firm’s
decision to issue new securities as a sign of possible bad news and then pricing new
securities accordingly. They will demand a premium to invest, or firm can only issue
equity at a discount. Aware of the resulting dilution of current shareholders’ wealth,
firms may not issue new equity even for projects with positive net present values,
causing what is known ‘underinvestment problem, therefore, Myers and Majluf
(1984) argue that borrowing through debt instruments, especially the less risky ones,
helps firms mitigate the inefficiencies in their investment decisions that are caused by
the information asymmetry. Compared to equity, debt is likely subject to lower degree
of miss-evaluation or adverse selection problem, simply because debt contracts are
safer in that they limit the possible ways by which holders could loose.
C. Corporate Governance and Capital Structure

Corporate governance issues arise because of separation between ownership

and control (Berle and Means, 1934). This separation gives managers the
discretionary to run the company, manage fund, and make another decisions for and
behalf of the owner. Using this discretionary, managers may not act in the best
interest of owner because of conflict of interest (agency problem). Because managers
have more information than the owners (asymmetric information), they may engage in

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 7
 self serving behavior. That is, they make decisions that will benefit them at the
expense of owner.
The key elements of corporate governance is concern with the enhancement
of corporate performance via the supervision, or monitoring, of management
performance and ensuring the accountability of management to shareholders and other
stakeholders base on the regulatory framework (Keasey and Wright, 1997). One of
the corporate governance mechanisms that can be used to align managers’ and
owners’ interest is ownership concentration (Denis et al.,1999; Demsetz and Lehn,
1985). This concentration may serve to limit managerial discretion or to align
managers’ and owners’ interest. By concentrating ownership, shareholders have
incentive to monitor managers, so they act in the best interest of shareholder.
One of the corporate governance mechanisms that can be used to align interest
of principal and agent (obviates agency cost) is ownership concentration (Denis et
al.,1999; Demsetz and Lehn, 1985). Two key aspect of ownership structures are
concentration and composition (Zhuang et al.,2000).
Shleifer and Vishny (1997) explain that ownership concentration, despites its
common use, has its costs as well, which can be best describes as potential
expropriation by large investors of other investors and stakeholders of the firm. Other
potential cost is that large shareholders are not diversified, and hence bear excessive
risk. Other explanation of ownership concentration cost is Prowsen (1998).
Demsetz and Lehn (1985) describe that ownership concentration obviates
conflict of interest between owner and manager, because owners have incentives to
monitor manager. This conflict arises because divergent of interest between owner
and manager. But, large shareholding, despite its common use, has its cost as well
(Shleifer and Vishny, 1997). There are two potential cost of ownership concentration
(Prowsen, 1998). If large shareholders become so powerful that they can control the
firm, they could divert wealth from other, outside or shareholders. For example, pay
themselves special dividends, extract greenmail from the firm, or force the firm to
make sweet heart deals with other companies they own to transfer wealth to
themselves. Another cost of concentration is, a question who monitors the monitor. In
this case, institutions that are big shareholders may be too lax in protecting their own
interests because they may also have governance problems.
The last two explanations, describe that large shareholding, despite its
common use, has its cost as well, even in industrial countries. Specifically in the Asia
Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 8
 countries, the corporate governance issues are different from Anglo Saxon. Large
shareholding in Asia countries, represent their own interest even at the cost of
minority. Large shareholding, then could decrease firm performance.
Some research in capital structure are related to agency costs, which costs are
based on conflicts of interest. Those research are based on agency problems
developed by Jensen and Meckling (1976) that developed the Fama and Miller
(1972). Jensen and Meckling identify two kinds of conflict of interest. First, the
conflict of interest between shareholders (shareholder / owner of the company) and
the manager because the manager has a net value of less than 100%. The consequence
of this is that managers do not receive the entire profit of the company's activities
even though they are running all activities of the company. An example of agency
costs that may arise is, managers use company resources for personal gain, for
example by improving the facilities in a way of furnish office or other facility in
excess. As a result of this is the inefficiency in the operations of the company that will
result in decreased value of the company. This inefficiency will decrease with an
increase in stock ownership by managers.
Conflicts between shareholders with the manager, one of which related to
capital structure. Jensen (1986) explained that the debt will require company funds
used to pay the debt. The funds will come out at the company reduces the availability
of funds and thus reducing possibility of use by the manager to its own interests. This
will eliminate the conflict between managers with shareholders as a result of the debt.
The existence of corporate debt on the one hand reduces the conflict of interest
between shareholders with the manager, but on the other hand led to the second
conflict, between shareholder with debtholder (the lender or debt). This conflict
occurs because of the debt contract allows shareholders to invest in less than optimal.
Debt contract allows an investment to get a big return on the value of the debt, then
the shareholder will have many advantages because of the advantage given to the debt
holder is limited to interest expense as a contract that has been approved. Conversely,
if the investment fails, the debt holder will bear the loss because shareholders have
limited liability to third parties. As a consequence, shareholders may benefit if the
company is losing money, such as investing in a risky project with debt financing.
These investments will reduce the value of the company that will also lower the value
of the debt. If project risk is managed with great benefit then the shareholder would
enjoy. Conversely if the risky project fails, then the creditor will bear the risk.
Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 9
III. RESEARCH METHOD

A. Sample selection

Samples in this study are public companies, listed in the Indonesian Stock Exchange
between 2001-2007. The samples are selected using purposive sampling, base on the
following criterias:
a. Listed in the Indonesian Stock Exchange between 2002-2007
b. The financial statement data are available for the reporting year 2001 – 2007.
c. The sample firms publish audited financial statements using reporting period
ended on December 31.
B. Model
Research model was used to test the pecking as Shyam-Sunder and Myers (1999) and
Cotei and Farhat (2008). Shyam-Sunder and Myers (1999) developed a model of the
pecking order theory, where if the company needs funds from external parties, it will use
debt rather than equity. Equity will only be used in very urgent, that is if the costs of
financial distress due to be so high and the company's debt capacity has been exceeded.
The first step is to solve equation (1). Equation (1) is used to test equation (2), (3), and
(3). Each model with an explanation of the variables are described as follows.
∆LTDt + ∆STDt + ∆EQt = Divt + It + ∆WCt – Ct = Fint (1)
Where:
∆ : Change of variables from time t-1 to t
LTDt : Long-term debt time t
STDt : Short-term debt time t
EQt : Equities time t
Divt : Cash dividend time t
It : Investment time t
WCt : Working Capital time t
Ct : Cash time t
Fint : Deficit / Surplus of Finance time t

∆TDt = α 0 + α1Fint+ φt (2)

Base on the Shyam-Sunder and Myers (1999) and Cotei and Farhat (2008) total
financing debt is separated into long-term debt and short-term debt as follows.

TDt = LTD t+ STDt

∆LTDt = δ 0 + δ1Fint+ v t (3)
∆STDt = γ 0 + γ1Fint + ξ t (4)
The simplest form of the pecking order model is the prediction that α 0 is zero and α1
close to 1.
δ 0 +γ 0 = α 0 ; δ1+ γ1 = α1 Konstanta (constant)
Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 10
 φt ; v t ; ξt error terms
The second objective of this study is tested using following model

∆TDt = α 0 + α1Fint+ α2DOMt+ α3NCOMt + α4NDIRt+ α5SIZEt + α6INDt + φt (5)

TDt = LTD t+ STDt
∆LTDt = δ 0 + δ1Fint+ δ2DOMt + δ3NCOMt+ δ4NDIRt+ δ5SIZEt + δ6INDt+ v t (6)
∆STDt = γ 0 + γ1Fint + γ2DOMt + γ3NCOMt + γ4NDIRt+ γ5SIZEt + γ6INDt+ ξ t (7)

Where :
DOM : Ownership concentration by Domestic Institution
NCOM : Number of Commissioners
JDIR : Number of the Board of Directors
SIZE : Total Asset as control variable
IND : Industry Dummny, 1 for Manufacture adn 0 for Service
δ 0 +γ 0 = α 0 ; δ1+ γ1 = α1 Konstanta (constant)
φt ; v t ; ξt error terms

DOM, NCOM and NDIR are corporate governance structure. DOM is ownership
proportion by domestic institutions used to measure ownership concentration using
herfindahl index (Demsetz and Lehn, 1985; Claessens, 1997). Herfindahl index domestic
institution (DOM) is the sum of square from proportion by domestic institution, compute
using the following formula:
n
DOM = Σ (Proportion of D Ii2) (8)
i=1
n
Where:
DOM : Herfindahl Index of domestic institution
Proportion of DIi : Ownership proportion by domestic institution
n : Number of domestic institution

IV. RESULTS AND DISCUSSIONS

This section describes the research finding, consists of descriptive, correlation, multiple
comparation and pecking order testing.
A. Descriptive Statistics
Descriptive statistics of variables are as in table 2 with minimun and
maximum value, mean and standard deviation. The minimum value of the change in
total debt,change in long term debt, change in short-term debt and the deficit / surplus
are, -30811400, -15557500, -14480000 and -6903140 respectively. Value minus

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 11
 (negative) for the changes indicate that there is a decline in total debt, long term debt
and short-term debt. The maximum value of the change in total debt,change in long
term debt, change in short-term debt and the deficit/surplus are 251514000,
251514000, 46348700 and 274118000 respectively.
Table 2. Descriptive Statistics
Variables Std.
Minimum Maximum Mean Deviation
∆TD -30811400 251514000 421849.58 5578018.625
TD 0 289842000 3458860.13 1.735E7
∆LTD -15557500 251514000 384561.96 5438779.216
LTD 0 289836000 2603379.18 1.629E7
STD 0 46348700 662555.12 2495640.581
∆STD -14480000 46348700 313116.12 1770284.286
Equity -10326300 95495000 1035783.82 4219695.935
∆ Equity -95403600 78989200 159885.25 3130413.187
Dividend 0 6361 165.01 509.075
Investment 1 10891800 164754.13 651429.667
Working Capital 0 58036000 634230.17 2311919.607
Fin 1 -6903140 274118000 1879186.75 1.151E7
DOM 0 1 .17 .192
NDIR 2 18 4.58 2.203
NCOM 2 17 4.23 2.001
Assets 567 319086000 5201424.13 2.124E7
IND 0 1 .49 .500

B. Correlations
Table 3 presents pair-wise correlations among key variables. Most variables are
correlated each other. Fin (surplus/defisit in finance) is positive significantly
correlates with Equity (0.503), changes in long term debt (0.896), total debt (0.792),
short term debt (0.792), changes in total debt (0.898), changes in short term debt
(0.110), changes in equity (0.392), number of Directors (0.209), number of
Commissioners (0.205) and industry (0.172). Those correlations are all significant at
the 0.01 level (2-tailed). The governance structure, DOM has correlations to equity
(0.071), dividend (0.112), total debt (0.080), short term debt (0.056), and industry
(0.053). NDIR has correlations to equity (0.201), changes in long term debt(0.172),
total debt (0.080), short term debt (0.185), changes in total debt (0.181), changes in

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 12
 Table 3. Pair-wise correlations among key variables
Assets Equity Dividend Investme Working ∆ Equity Fin 1 DOM NDIR NCOM IND
∆LTD TD STD ∆TD ∆STD
Assets - . . -
628** .018 094** 037 455** 983** 230** 456** 116** 195** 779** 089** 305** 302** .121**
Equity .628** . . . -
042 283** 347** 145** 476** 460** 151** 314** 447** 503** 071** 201** 249** .020
Dividend -.018 1 . . .
042 084 062 .017 .025 027 .009 008 015 .018 112* 016 057 218**
Investment .094** . - . -
283** 084 .033 .009 063* 353** 011 108** 236** 013 .035 023 176** .126**
Working .037 . 1 . .
Capital 347** 062 .033 000 .038* .295** .049** 191** 223** 015 033 013 005 021
∆LTD .455** - . . -
145** .017 .009 000 481** .005 967** 034* 081** 896** 037 172** 165** .108**
**
TD .983 - - . -
476** .025 063* .038* 481** 160** 481** 060** 117** 792** 080** 298** 281** .130**
STD .230** . - . .
460** 027 353** .295** .005 160** 071** 308** 160** 079* 056* 185** 248** 043*
∆TD .456** - - . -
151** .009 011 .049** 967** 481** 071** .028 124** 898** 020 181** 161** .133**
**
∆STD .116 . . . .
314** 008 108** 191** 034 060** 308** .028 037* 110** 035 089** 130** 042
∆ Equity .195** . . . -
447** 015 236** 223** 081** 117** 160** 124** 037* 392** .003 050* 044* .021
**
Fin 1 .779 - . . -
503** .018 013 015 896** 792** 079* 898** 110** 392** 057 209** 205** .172**
DOM .089** . . - .
071** 112* .035 033 037 080** 056* 020 035 .003 057 016 .015 053*
**
NDIR .305 . . . .
201** 016 023 013 172** 298** 185** 181** 089** 050* 209** 016 666** 039
NCOM .302** . . 1 -
249** 057 176** 005 165** 281** 248** 161** 130** 044* 205** .015 666** .051*
**
IND -.121 . . - 1
.020 218** .126** 021 .108** .130** 043* .133** 042 .021 .172** 053* 039 .051*
**. Correlation is significant at the 0.01 level (2-tailed).
*. Correlation is significant at the 0.05 level (2-tailed).

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 13
 short debt (0.089), changes in equity (0.050), surplus/defisit (0.209), and NCOM
(0.666). NCOM hascorrelations to equity (0.249), investment (0.176), changes in
longterm debt (0.165), total debt (0.281), short term debt (0.248), changes in total
debt (0.161), changes in short term debt (0.130), changes in equity (0.044),
surplus/defisit (0.205) and industry (0.051). There is no such high correlation except
for Fin (surplus/defisit in finance) with changes in long term debt, total debt, short
term debt and changes in total debt.
C. Multiple comparison between years
Table 4 presents the analysis of variance (anova) between years for Fin, ∆STD, ∆TD,
∆LTD, Equity and Share Outstanding. F value of ∆STD and share outstanding are
significant at the 0.01 level, equity is significant at the 0.05 level, while 4 other
variables are not significant. These mean that there are differences between years for
variable ∆STD, share outstanding and equity.
Table 4. Analysis of Variance
Variable F value Sig
Fin 1.302 0.253
∆STD 11.753*** 0.000
∆TD 1.268 0.269
∆LTD 0.833 0.544
∆LTD 0.764 0.598
Equity 2.331** 0.030
Share Outstanding 7.153*** 0.000
***significant at the 0.01 level (2-tailed), ** significant at the 0.05 level (2-tailed).

Multiple comparison then conducted for those 3 variables that statistically significant.
This comparison describes the trend of those variables. If there is a negative
differences between years, then there is a positive trend.
Table 5 describes multiple comparisons between years for variables ∆STD, equity and
share outstanding. Mean differences of ∆STD show that there are increasings in year
2001 to 2002 (616061.020), 2001 to 2004 (624329.834), 2001 to 2005 (506933.001),
2002 to 2004 (8268.814), 2003 to 2004 (671130.342), 2003 to 2005 (553733.510).
While the decreasing of ∆STD are in year 2002 to 2003 (662861.528), 2002 to 2006
(556054.222), 2002 to 2007 (469822.101), 2004 to 2006 (564323.037), 2004 to 2007
(478090.915), 2005 to 2006(446926.204) and 2005-2007 (360694.083). Those
increasing and decreasing suggest that there is no pattern of trend between years on
changes in short term debt.

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 14
 Mean differences of equity show that there are increasings in year 2001 to 2004
(1.113E6) and 2001 to 2007 (957204.115). This suggests that there is no such pattern
of trend in equity. Mean differences of share outstanding show that there are
increasings 2001 to 2006 (3.491E9), 2001 to 2006 (3.491E9), 2001 to 2007
(3.388E9), 2002 to 2006 (4.276E9 ), 2002 to 2007 (4.172E9), 2003 to 2006(4.278E9),
2003 to 2007 (4.175E9), 2004 to 2006 (4.273E9), and 2004 to 2007 (4.169E9). There
is no decreasing on share outstanding between years. Those differences suggest that
there is an increasing trend of hare outstanding.

Table 5. Multiple Comparison

YEARS ∆STD Equity Share Outstanding
Mean Diffirence Sig Mean Sig Mean Diffirence Sig
Diffirence
2001 2002 -616061.020*** .000 -320209.060 1.000 7.844E8 1.000
2003 -46800.508 1.000 -695539.212 1.000 7.869E8 1.000
2004 -624329.834***
.000 -1.113E6** .034 7.815E8 1.000
2005 -506933.001***
.001 -557253.232 1.000 -1.172E9 1.000
2006 60006.798 1.000 -639859.806 1.000 -3.491E9** .034
2007 146238.919 1.000 -957204.115* .094 -3.388E9* .003
2002 2003 662861.528*** .000 -375330.152 1.000 2496810.155 1.000
2004 -8268.814 1.000 -792961.455 .483 -2950360.893 1.000
2005 109128.018 1.000 -237044.172 1.000 -1.957E9 1.000
2006 556054.222*** 0.000 -319650.746 1.000 -4.276E9*** .002
2007 469822.101***
.003 -636995.055 1.000 -4.172E9*** .000
2003 2004 -671130.342***
.000 -417631.303 1.000 -5447171.049 1.000
2005 -553733.510***
.000 138285.980 1.000 -1.959E9 1.000
2006 -106807.306 1.000 55679.406 1.000 -4.278E9*** .002
2007 -193039.427 1.000 -261664.903 1.000 -4.175E9*** .000
2004 2005 117396.833 1.000 555917.283 1.000 -1.954E9 1.000
2006 564323.037***
.000 473310.709 1.000 -4.273E9*** .002
2007 478090.915*** .002 155966.400 1.000 -4.169E9*** .000
2005 2006 446926.204*** .006 -82606.574 1.000 -2.319E9 1.000
2007 360694.083* .070 -399950.882 1.000 -2.215E9 1.000
2006 2007 -86232.121 1.000 -317344.309 1.000 1.036E8 1.000

D. Pecking Order Testing

Table 6 presents the results of pecking order testing as in model (2), (3) and (4). The
regression results show that all three models are statistically significant at the 1%
level with F value of 4204.488, 4114.382 and 12.418 respectively for model (2), (3)
and (4). R square and adjusted R square are high only in model (2) and (3). As
described in model testing, the simplest form of the pecking order model is the

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 15
 prediction that α 0 is zero and α1 close to 1. The constant values of model (2), (3) and
(4) are -518047.500, -604977.747 and 265601.048 repectively with t values are all
statistically significant at the 1% level. These suggest that all α0 are not zero. The t
values of coefficient Fin (α1) of model (2), (3) and (4) are all statistically significant at
the 1% level and the coefficients are 0.658, 0.654 and 0.01138 respectively. Those
coefficients do not close to 1. Because of α 0 is not zero and α1 doesn’t close to 1 then
the pecking order is not supported. The results are consistent for model (2), (3) and
(4). The result of this study is supported Fama and French (2002), Frank and Goyal
(2003) and Flannery and Rangan (2006) that are not supproted the pecking order
model. One of the possibility explanation is that the listed companies funding their
company by additional listed shares since the results of multiple comparison between
years for share outstanding has positive trend (there is an increasing pattern between
year).
Table 6. Pecking Order Testing
The second, third and forth colomns are regression results of model (2), (3) and (4)
respectively. *** significant at α1%
∆TDt (model 2) ∆LTDt (model 3) ∆STDt (model 4)
Constant -518047.500 -604977.747 265601.048
t value (α0) -4.384*** -5.093*** 7.056***
Fin (α1) .658 .654 1.138E-02
t value 64.842*** 64.143*** 3.524***
F value 4204.488*** 4114.382*** 12.418***
R2 .898 .804 .012
Adjusted R2 .807 .803 .011
N (Number of 1007 1007 1007
Observation)

The second testing of pecking order conducted by adding the governance structure in
the model. The results are as in table 7. The regression results show that all three
models are statistically significant at the 1% level with F value of 405.275, 411.587
and 4.048 respectively for model (5), (6) and (7). R square and adjusted R square are
high only in model (5) and (6). This consistent with the result before that R square and
adjusted R square are high only in model with the dependent variable of changes in
total debt and changes in long term debt and low in the model with the dependent
variable of changes in short term debt.

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 16
 The constant values of model (5), (6) and (7) are -252445.529, -268705.806, -66942.375
repectively with t values are not statistically significant. These suggest that all α0 are
zero. The t values of coefficient Fin (α1) of model (5), (6) and (7) are all statistically
significant, (5) and (6) at the 1% level while (7) at the 5% level. The coefficients each
model are 0.446, 0.456 and 0,0342 respectively. These suggest that all α1 are not close
to 1. The result suggets that even α0 is zero but because of α1 doesn’t close to 1 then the
pecking order is not supported. The results are consistent for model (5), (6), (7) and
support the results of model (2), (3) and (4).
Table 7. Pecking Order and Governance Structure Testing
The second, third and forth colomns are regression results of model (5), (6) and (7)
respectively. *** significant at α1%
∆TDt (model 5) ∆LTDt (model 6) ∆STDt (model 7)
Constant -252445.529 -268705.806 -66942.375
t value -1.226 -1.323 -.439
Fin .446 .456 3.427E-02
t value 22.783*** 23.603*** 2.362**
DOM 162911.791 141064.591 195810.196
t value .507 .445 .823
NCOM 78792.356 86085.986 -31957.756
t value 1.513 1.676 -.828
NDIR -11366.317 -33886.722 100748.905
t value -.284 -.859 3.401***
ASSETS -3.220E-02 -3.644E-02 -8.703E-03
t value -4.711*** -5.407 -1.719**
IND -203509.172 -169633.977 -87512.991
t value -1.362 -1.151 -.791
F value 405.275*** 411.587*** 4.048***
R2 .856 .858 .056
2 .854 .856 .042
Adjusted R
N (Number of 417 417 417
Observation)

The variable of governance structures consist of DOM as a proxy of ownership

concentration, number of Comissioners (NCOM) and number of Directors (NDIR).
DOM and NCOM are not statistically significant for all model. NDIR significant at level
1% only in model (7). These suggest that governance structures do not influence capital
structure.

Proceedings of the 36th Federation of ASEAN Economic Associations (FAEA) Conference 2011 Page 17
V. CONCLUSION

This study presents an analysis of the Pecking Order Theory (POT) of capital
structure. POT explains that the order of financial sources used by the company was the
source of internal funds from profits, short-term securities, debt, preferred stock and
common stock last. Pecking order theory predicts that the issuance of equity (common
stock) is the last alternative sources of funding.
Samples in this study are companies listed in the IDX during 2001-2007. The
research questions are tested by running regression models as in Shyam-Sunder and Myers
(1999) and Cotei and Farhat (2008). This study extends the test of POT by examining the
impact of governing mechanism (ownership structure) on POT.
The first objective of this study is to test whether the listed companies in IDX
follow the Pecking Order Theory (POT) using model (2), (3) and (4). The second
objective of this study is to examine the impact of governing mechanism (ownership
structure) on pecking order theory of capital structure using model (5), (6) and (7).
The result of the first test shows that α 0 is not zero and α1 doesn’t close to 1. This
suggests that POT is not supported. The results are consistent for model (2), (3) and (4).
The result of the second tets shows that even α0 is zero but α1 doesn’t close to 1. This
suggests that the POT is not supported. The results are consistent for model (5), (6), (7)
and support the results of model (2), (3) and (4). The result of this study is supported
Fama and French (2002), Frank and Goyal (2003) and Flannery and Rangan (2006)
that are not supproted the pecking order model. One of the possibility explanation is that
the listed companies funding their company by additional listed shares since the results
of multiple comparison between years for share outstanding has positive trend (there is
an increasing pattern between year). The variable of governance structures consist of
DOM as a proxy of ownership concentration, number of Comissioners (NCOM) and number
of Directors (NDIR). DOM and NCOM are not statistically significant for all model. NDIR
significant at level 1% only in model (7). These suggest that governance structures do not
influence capital structure.

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