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Unformatted text preview: site as profitable firms have a larger scope for tax shields and therefore
subsequently should have higher debt levels). Download free ebooks at bookboon.com
65 Corporate Finance Corporate ﬁnancing and valuation 8.9 The pecking order theory of capital structure
The pecking order theory has emerged as alternative theory to the trade-off theory. Rather than introducing
corporate taxes and financial distress into the MM framework, the key assumption of the pecking order
theory is asymmetric information. Asymmetric information captures that managers know more than
investors and their actions therefore provides a signal to investors about the prospects of the firm.
The intuition behind the pecking order theory is derived from considering the following string of
– If the firm announces a stock issue it will drive down the stock price because investors believe
managers are more likely to issue when shares are overpriced.
Therefore firms prefer to issue debt as this will allow the firm to raise funds without send...
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This note was uploaded on 10/26/2012 for the course 19 19 taught by Professor - during the Spring '12 term at Sunway University College.
- Spring '12