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PECKING ORDER THEORY
FINANCIAL MANAGEMENT
CONCEPTUAL SERIES FOR COMPETITIVE EXAM FOR COMMERCE AND ACCOUTNACNY
C.S.E MAIN EXAM COMMERCE AND ACCOUNTANCY
FINANCIAL MANAGEMENTCONCEPTUAL SERIES FOR COMPETITIVE EXAM FOR COMMERCE AND ACCOUTNACNY
C.S.E MAIN EXAM COMMERCE AND ACCOUNTANCY
PECKING ORDER THEORY/MODEL
1.
DEVELOPED BY STEWART C MYERS AND NOCLAS MAJLUF
IN 1984
2.
BASED ON THE ASSERTION THAT MANAGERS HAVE MORE
INFORMATION ABOUT THEIR FIRM THAN INVESTORS
3.
DISPARITY OF INFORMATION IS KNOWN AS ASYMMETRIC
INFORMATION
4.
OTHER THING BEING EQUAL BECAUSE OF ASYMMETRIC INFORMATION,MANAGER WILL ISSUE DEBT WHEN THEY ARE POSITIVE ABOUT THEIR FIRM’S
FUTURE PROSPECTS AND WILL ISSUE EQUITY WHEN THEY ARE UNSURE.
5.
IT STATES THAT COMPANIES PRIORITIZE THEIR SOURCE
OF FINANCING FROM INTERNAL FINANCING TO EQUITY
6.
INTERNAL FUNDS ARE USED FIRST,THEN DEBT AND
WHEN IT IS NOT SENSIBLE TO ISSUE ANY MORE DEBT,THEN EQUITY
7.
MANAGERS ADHERE TO HIERARCHY OF FINANCING
SOURCE AND PREFER INTERNAL FINANCING WHEN AVAILABLE AND DEBT IS PREFERRED OVER
EQUITY IF EXTERNAL FINANCING IS
◦
PECKING ORDER
◦
RESLUST FROM OBSERVED BEHAVIOR BASED ON SURVEY
BY GORDON DONALDSON AND FROM ASYMMETRIC INFORMATION:-
1.
MANAGERS ALWAYS PREFER TO USE INTERNAL FINANCE.
AS INTERNAL FINANCE IS CHEAPER AS NO TAX ARE PAID ON RETAINED EARNING AND NO
TRANSACTION COST
2.
WHEN THEY DO NOT HAVE INTERNAL FINANCE,PREFER
ISSUING DEBT. FIRST SECURE DEBT.THEN
UNSECURE DEBT AND THEN HYBRID SECURITIES SUCH AS CONVERTIBLE DEBENTURES.
3.
AT LAST RESORT,MANGERS ISSUE SHARES TO RAISE
FINANCES.
◦
EVALUATION
1.
ABLE TO EXPLAIN THE NEGATIVE RELATIONSHIP
BETWEEN PROFITABILITY AND DEBT RATIO WITH IN THE INDUSTRY.
2.
MANAGERS AVOID SIGNALLING ADVERSE INFORMATION
ABOUT THEIR COMPANY BY USING INTERNAL FINANCE
3.
THE PROFITABLE FIRMS HAVE LOWER DEBT RATIO NOT
BECAUSE THEY HAVE LOWER TARGET RATIO BECAUSE THEY HAVE INTERNAL FUNDS TO
FINANCE THEIR ACTIVITIES.
◦
LIMITATIONS
.IT DOES NOT
FULLY EXPLAIN THE CAPITAL STRUCTURE DIFFERENCES BETWEEN INDUSTRIES
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