An important prediction of the pecking order theory is that an announcement of a new share issue will cause the company's:

Question

Quizplus · Accepted Answer

The pecking order theory suggests that companies prefer internal financing (retained earnings) over external financing (debt or equity) to avoid information asymmetry and agency costs. When a company announces a new share issue, it signals to investors that it cannot fund its investment opportunities through retained earnings, which could imply that the company is experiencing financial difficulties, and its future prospects are uncertain. As a result, investors may interpret the announcement as negative news and start selling their shares, leading to a drop in the share price. Therefore, choice A is the best answer.

An Important Prediction of the Pecking Order Theory Is That