Pecking Order Theory in Capital Structure Decisions

In a research study presented during a corporate finance seminar, a prominent scholar discussed the implications of the Pecking Order Theory in capital structure decisions. According to this theory, firms prioritize their sources of financing based on the principle of least effort, choosing internal financing over external financing, and preferring debt over equity when external financing is necessary.

This scholar provided empirical data about two distinct companies in the same industry, Company X and Company Y. Company X has consistently funded its expansion projects using retained earnings and has avoided issuing new equity despite experiencing high growth rates. In contrast, Company Y has a history of issuing new equity to finance its investments, particularly when market conditions are favorable for equity issuance. The scholar concluded with a challenge: “Which company is more likely to adhere to the Pecking Order Theory in its capital structure decisions?”