Financial Management: Core Concepts, Third Edition

16.4 Pecking Order

Does it matter from what source the company obtains funding? Is there a preferred financing order?

Simple logic tells us we should use the cheapest source first and then move to the next cheapest source. One theory, in fact, holds that companies do tend to prioritize their sources of financing. According to the theory, they proceed from internal funding to debt and finally to equity as a last resort. This movement from one source of funding to another in a preferred order we call the pecking order hypothesis. At its base, the pecking order hypothesis builds from the concept of asymmetric information. Information is asymmetric when one party in a transaction has a different set of information from the other party in the transaction. ...