Understanding Pecking Order Theory in Financing Decisions

Very Easy Capital Structure Decisions Pecking Order Theory

In the context of corporate finance, the Pecking Order Theory suggests that companies prioritize their sources of financing (from internal to external) based on the principle of least effort, or resistance. This theory posits that firms prefer to fund themselves first with internal funds, such as retained earnings, before considering debt, and lastly issuing equity.

Which of the following statements best reflects the implications of the Pecking Order Theory regarding a firm's financing decisions?

Firms will always prefer issuing debt over equity regardless of the circumstances.

Firms prefer using retained earnings, then debt, and finally new equity for financing.

Firms will issue equity first when external financing is needed.

Hint

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