Pecking order theory

The financing hierarchy is commonly explained by information asymmetry, transaction costs and the signals investors infer from new issues. Managers may know more about the business than outside investors, making external equity particularly sensitive to perceived misvaluation. The theory describes tendencies rather than a mandatory rule and does not necessarily imply a fixed target gearing ratio. Profitable firms may use less debt because they generate internal funds, while funding needs can increase borrowing. Practical constraints and strategic objectives can override the hierarchy in a particular case.