The pecking order theory of capital structure implies that:
I. Risky firms will end up borrowing more
II. Firms prefer internal finance
III. Firms prefer debt to equity when external financing is required

Question

Quizplus · Accepted Answer

The pecking order theory states that firms prefer internal finance (retained earnings) first, then debt, and finally equity as a last resort. This is because equity issuance sends a negative signal to the market. Additionally, the theory suggests that risky firms will end up borrowing more, as they have limited access to external equity financing. Therefore, statements II and III are both true, while statement I is not necessarily true for all firms.

The Pecking Order Theory of Capital Structure Implies That