signal a lack of confidence in the board and that they feel the share price is over-valued. An issue of equity would therefore lead to a drop in share price. This does not however apply to high-tech industries where the issue of equity is preferable due to the high cost of debt issue as assets are intangible. Evidence Tests of the pecking order theory have not been able to show that it is of first-order importance in determining a firm's capital structure. However, several authors have found that there are instances where it is a good approximation of reality. Zeidan, Galil and Shapir (2018) document that owners of private firms in Brazil follow the pecking order theory, and also Myers and Shyam-Sunder (1999) find that some features of the data are better explained by the pecking order than by the trade-off theory. Frank and Goyal show, among other things, that pecking order theory fails where it should hold, namely for small firms where information asymmetry is presumably an important problem. Profitability and debt ratios The pecking order theory explains the inverse relationship between profitability and debt ratios: Firms prefer internal financing. They adapt their target dividend payout ratios to their investment opportunities, while trying to avoid sudden changes in dividends. Sticky dividend policies, plus unpredictable fluctuations in profits and investment opportunities, mean that internally generated cash flow is sometimes more than capital expenditures and at other times less. If it is more, the firm pays off the debt or invests in marketable securities. If it is less, the firm first draws down its cash balance or sells its marketable securities, rather than reduce dividends. If external financing is required, firms issue the safest security first. That is, they start with debt, then possibly hybrid securities such as convertible bonds, then perhaps equity as a last resort. In addition, issue costs are least for internal funds, low for debt and highest for equity. There is also the negative signaling to the stock market associated with issuing equity, positive signaling associated with debt. See also Capital structure substitution theory Corporate finance Cost of capital Market timing hypothesis Trade-off theory of capital structure References Corporate finance Asymmetric information Debt Finance theories