The Pecking Order Theory
Theoretical Approach
Pecking Order theory
The pecking order theory is a financial management theory that was developed by Donaldson in 1961, and was modified by Stewart and Nicolas Majuluf in 1984 (M.Z Frank and V.K Goyal, 2003). I chose this theory because it is one of the most important theories in financial management, it applicable in my study because it shows how important financial management skills and decisions are in ensuring sustainability and profitability of a business.
A business has three sources of finance which are retained earnings (internal funds), equity and debt (external funds). The pecking order theory suggests that businesses prefer internal to external finance. This means that management would rather finance first from retained earnings, then with debt (short term then long term debt) and lastly with externally issued equity. A business will first use up all its retained earnings, then will move on to short term debt and long term debt and will only issue equity when it is no longer wise to issue debt. Internal finance has the least risk, debt is preferred to equity because it has lower information costs. Retained earnings do not have an adverse selection problem, while debt and equity have an adverse selections problem (M.Z Frank and V.K Goyal, 2003).
A financial manager needs to have the required skills e.g., management of financial resources, critical thinking, decision making, co ordination in order to apply the pecking order theory. Financial management of working capital determines the direction a business will take, effective management of working capital is essential if the business wants to make a profit. Financial management skills affect the capital structure of the business and are important as they play a key role in achieving better performance. A bad decision about the capital structure may lead to financial problems and even bankruptcy.
If a financial manager is able to make accurate and timely decisions he/she is
Pecking Order theory
The pecking order theory is a financial management theory that was developed by Donaldson in 1961, and was modified by Stewart and Nicolas Majuluf in 1984 (M.Z Frank and V.K Goyal, 2003). I chose this theory because it is one of the most important theories in financial management, it applicable in my study because it shows how important financial management skills and decisions are in ensuring sustainability and profitability of a business.
A business has three sources of finance which are retained earnings (internal funds), equity and debt (external funds). The pecking order theory suggests that businesses prefer internal to external finance. This means that management would rather finance first from retained earnings, then with debt (short term then long term debt) and lastly with externally issued equity. A business will first use up all its retained earnings, then will move on to short term debt and long term debt and will only issue equity when it is no longer wise to issue debt. Internal finance has the least risk, debt is preferred to equity because it has lower information costs. Retained earnings do not have an adverse selection problem, while debt and equity have an adverse selections problem (M.Z Frank and V.K Goyal, 2003).
A financial manager needs to have the required skills e.g., management of financial resources, critical thinking, decision making, co ordination in order to apply the pecking order theory. Financial management of working capital determines the direction a business will take, effective management of working capital is essential if the business wants to make a profit. Financial management skills affect the capital structure of the business and are important as they play a key role in achieving better performance. A bad decision about the capital structure may lead to financial problems and even bankruptcy.
If a financial manager is able to make accurate and timely decisions he/she is
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