Business
Pecking Order Theory
The Pecking Order Theory in business refers to the concept that companies prefer to use internal financing rather than external financing, and when external financing is necessary, they prefer debt over equity. This theory suggests that firms have a hierarchy of financing sources, with retained earnings being the most preferred, followed by debt, and then equity as a last resort.
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2 Key excerpts on "Pecking Order Theory"
- Robert Blackburn, Dirk De Clercq, Jarna Heinonen(Authors)
- 2017(Publication Date)
- SAGE Publications Ltd(Publisher)
17 Financing Entrepreneurial Ventures Colin Mason Introduction The Pecking Order Theory is a long-standing feature in the entrepreneurial finance literature (Myers, 1984). It suggests that firms adopt a ranking of sources of finance. For cost and control reasons firms will prefer internal finance (personal funds, retained profits) over external finance. When external finance is required then debt will be preferred over equity, which requires the sale of shares in the business and hence dilutes control by bringing external investors into its ownership. But in reality new businesses with growth ambitions – which we will term entrepreneurial businesses – are likely to encounter the ‘valley of death’ (Figure 17.1), which describes the situation in which they encounter a period of negative cash flow resulting from heavy expenditure on research and development, product development and scaling up before their product or service brings in sufficient revenue from customers to generate profits. Banks seek to lend to established businesses that are profitable, have collateral as security for the loan and strong cash flow to repay the loan. Businesses in the ‘valley of death’ do not meet any of these criteria. This means that entre-preneurial businesses – and new technology-based firms in particular – will turn to equity finance at a much earlier stage in their development than predicted by the pecking order hypothesis (Riding, Orser & Chamberlin, 2012; Sjögren & Zackrisson, 2005). However, even providers of equity finance – primarily business angels and venture capital funds – are unlikely to invest in firms at the start-up stage because they are too ‘informationally opaque’ (Berger & Udell, 1988)
eBook - ePubTourism, Hospitality and Digital Transformation
Strategic Management Aspects
- Kayhan Tajeddini, Vanessa Ratten, Thorsten Merkle(Authors)
- 2019(Publication Date)
- Routledge(Publisher)
6THE APPLICATION OF THEORIES ABOUT CAPITAL STRUCTURE
Pecking order, trade-off and signaling in the hotel units in Portugal
Aida Maria de Brito Martins, Joaquim Carlos da Costa Pinho and Graça Maria do Carmo Azevedo6.1 Introduction
Decisions about the components of the capital structure, that is, how companies use their own and other capital to finance their assets, are critical to companies (Couto & Ferreira, 2010; Singh et al., 2014). Over the last few decades, several theories on capital structure have been developed, notably Trade-off (Kraus & Litzenberger, 1973; Scott, 1977; Kim, 1978), Pecking order (Myers, 1984) and Signaling (Leland & Pyle, 1977; Ross, 1977). According to the Trade-off theory, the companies aim to achieve an optimal level of debt, which takes into account the combination between tax benefits of debt and the costs of insolvency of the company, whereas for the theory Pecking order the changes in debt are a consequence of the financial needs of companies, which must exhaust domestic sources of financing first, followed by indebtedness and only in the last option the issuance of capital abroad. Signaling theory is based on the asymmetry of information between two parties (Connelly et al., 2011) and argues that the value of securities issued by companies will depend on how investors will interpret financial decisions as evidence of future corporate income streams; higher levels of debt issuance may be interpreted as positive signs.The various studies carried out on the capital structure of companies have concluded that this is related to some business characteristics. These studies have been applied to different sectors of business activity in different countries, and the results obtained have been divergent (Titman & Wessels, 1988; Couto & Ferreira, 2010; Serrasqueiro & Nunes, 2012; Wellalage & Locke, 2013; Kühnhausen & Stieber, 2014; De Luca, 2015; Serrasqueiro & Caetano, 2015; Panagiotis, 2016).
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