6.

Pecking order theory

Pecking order theory by Myers and Majluf (1984) - This theory indicates that when a company needs
cash to invest in new projects, the company will comply with the order of each step, there is a priority
order. Firstly, the company's profit will be announced; however, these profits will not be distributed to
investors. The company will use their profits to invest in new projects or business organizations. Secondly,
the company will use the loan procedure, also known as debt leverage; they will seek funds by borrowing
from banks or other credit institutions. The company will select the issuance of shares to the stock market.
The issuance of shares will bring strong cash position for the company; companies need to leverage this
investment to invest in their projects. Besides, the increase of the stock will increase the confidence of
investors that the company possesses good projects and they are operating effectively. Investors will look
at the valuation of the stock is higher than its true value. In summary, when applying Pecking order theory,
the company will take steps as follows: Use of internal cash, the use of leverage, stock issuance is the
final step.
The capital structure decisions ability to implement business strategies. In finance, the capital structure
owns many theories - each theory leads to a different recognition. Besides the pecking order theory, the
theory of capital structure typical as: The Modigliani and Miller theorem by Franco Modigliani and
Merton Howard Miller; Static trade-off theory. According to The Modigliani and Miller theorem, Debt
and interest expense (tax deductible) will increase company value; the company's value is maximized if
they would use the loan at the rate of 100%. Besides the benefits of using debt, the risks of this action are
not small. It will put pressure on the company's finances; company will bear the burden of interest rates
and the financial risk. When market interest rates fluctuate, capital contributions from shareholders is not
significant then the company will be bankrupt. In fact, the use of debt at the rate of 100% is adventurous
and very rare. In the static trade-off theory, companies will be fighting their own financial resources; they
must decide the financial leverage to ensure balance benefits received from loans and financial risks.
When using loans, the value of the company will be increased by the tax deductions; however, the
increase in the debt ratio will increase the financial risk. An easy way to recognize that not exist a capital
structure to use for all according to the pecking Order Theory. Each sector should be based on actual
situations, scale and how their activities to choose appropriate capital structure.