- This topic has 5 replies, 2 voices, and was last updated 5 years ago by
.
- Posts
Good day sir,
I would like to enquire about the pecking order theory. As we know, the financing hierachy will be from internal funds, followed by debt and lastly the equity.
In pecking order theory, we priotize debt over equity in terms of equity financing, is it because of the tax-shield benefits which will reduce the WACC OR it is because it signals that the company is confidence that the company can meet its obligation?
Which reason is mentioned in the pecking order theory???
Thanks sir
Pecking order theory simply suggests that finance should be raised in the order in which it is most easily obtained – using retained earnings being the first preference because the money is immediately available. (It is M&M theory that prefers debt finance because of the tax benefit. This is not the reason for the order in pecking order theory.)
This is explained in my free lecture notes and the lectures that go with the notes.
How about the following reasons. Is it applied to pecking order theory?
using debt financing signals that the company is confidence that the company can meet its obligation, while using equity financing gives negative signals that negative signal that the stock is overvalued and their share price might be about to drop.
Thanks
No – that is not part of pecking order theory.
In a more general sense, using debt finance might signal confidence, but it depends on the circumstances. There is no reason why using equity finance gives negative signals, unless there are other factors involved (as to why they are raising the money in the first place).
OK sir, then what is the reason behind we use debt finance over equity finance in pecking order theory???
except talking about it is easily obtained as compared to equity
Thanks you very much
- You must be logged in to reply to this topic.