Pecking order theory

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The pecking order theory (Engl. Pecking Order Theory ) or pecking order model was first described by Gordon Donaldson proposed and in 1961 by Stewart Myers and Nicolas Majluf modified in 1984. She postulates that the cost of funding increases with the severity of the asymmetric information problem.

The pecking order theory thus states that companies prioritize their sources of funding (from internal funding to equity) according to the principle of least effort or least resistance, and prefer to use equity as a source of funding only as a last resort. Therefore, internal funds (such as retained earnings ) are drawn on first, when they are used up, debt is taken on, and when it no longer makes sense to take on more debt, equity is spent.

theory

The pecking order theory arises from the presence of asymmetrical information, as managers know more about the prospects, risks and values ​​of a company than outside, potential investors. Asymmetrical information therefore influences the choice between internal and external financing, as well as the choice between debt and equity. Therefore, there is a pecking order or prioritized order when financing new projects:

  1. Internal financing ( e.g. profit retention )
  2. Outside capital (e.g. bank loan)
  3. Hybrid securities (e.g. convertibles )
  4. Equity (e.g. issue of new shares)

The issuance of new equity, for example by issuing new shares, signals a lack of trust in the management board and that the company's own shares are currently tending to be overvalued. Therefore, issuing new equity would lead to a falling share price. Vice versa, the raising of new outside capital signals that the management board believes in the profitability of the project and that the share price is currently tending to be undervalued.

High-tech companies, which often prefer to issue new equity, are an exception . Due to the few tangible assets , the granting of loans by financial intermediaries is associated with high monitoring costs, which are passed on to the company, for example in the form of high interest payments, and thus make it expensive to raise new debt.

Empirical research

Empirical studies have not been able to show that pecking order theory is the most important dominant of capital structure. Nevertheless, several authors were able to show that it still represents a good approximation of reality.

Fama and French as well as Myers and Shyam-Sunder were able to show that pecking order theory can explain the data better than the static trade-off theory of capital structure .

On the other hand, Goyal and Frank showed that, in the event of a funding deficit, companies raise new borrowed capital, but other determinants also play a significant role and the size of the financial deficit correlates even more strongly with the newly borrowed net equity than with the newly borrowed capital. The pecking order theory fails especially with small companies. Because of the asymmetrical information, it should actually most likely stop here.

Individual evidence

  1. ^ Donaldson, Corporate debt capacity; a study of corporate debt policy and the determination of corporate debt capacity, Graduate School of Business Administration, Harvard 1961.
  2. ↑ Stewart C. Myers, Nicholas S. Majluf: Corporate financing and investment decisions when firms have information that investors do not have . In: Journal of Financial Economics . tape 13 , no. 2 , p. 187–221 , doi : 10.1016 / 0304-405x (84) 90023-0 ( elsevier.com [accessed August 12, 2017]).
  3. ^ Eugene F. Fama, Kenneth R. French: Testing Trade-Off and Pecking Order Predictions About Dividends and Debt . In: Review of Financial Studies . tape 15 , no. 1 , January 1, 2002, ISSN  0893-9454 , p. 1–33 , doi : 10.1093 / rfs / 15.1.1 ( oup.com [accessed August 12, 2017]).
  4. ↑ Lakshmi Shyam-Sunder, Stewart C. Myers: Testing static tradeoff against pecking order models of capital structure1This paper has benefited from comments by seminar participants at Boston College, Boston University, Dartmouth College, Massachusetts Institute of Technology, University of Massachusetts, Ohio State University, University of California at Los Angeles and the NBER, especially Eugene Fama and Robert Gertner. The usual disclaimers apply. Funding from MIT and the Tuck School at Dartmouth College is gratefuly acknowledged. We also thank two reviewers, Richard S. Ruback and Clifford W. Smith, Jr., for helpful comments . In: Journal of Financial Economics . tape 51 , no. 2 , February 1, 1999, p. 219-244 , doi : 10.1016 / S0304-405X (98) 00051-8 ( sciencedirect.com [accessed August 12, 2017]).
  5. ^ Murray Z. Frank, Vidhan K. Goyal: Testing the Pecking Order Theory of Capital Structure . ID 243138. Social Science Research Network, Rochester, NY December 7, 2000 ( ssrn.com [accessed August 12, 2017]).