Pecking Order Theory

Pecking Order Theory

1. History and Background
 The Pecking Order Theory, also known as the Pecking Order Model,
relates to a company’s capital structure.
 Presented by Stewart Myers and Nicolas Majluf in 1984, the theory
states that managers follow a hierarchy when considering sources of
financing.
 Pecking order theory is the idea that company managers decide how to
finance company operations based on a hierarchy where they first use
retained earnings (internal financing), then debt financing, then equity
financing.
 Pecking Order Theory
2- The Preferences of companies managers
 1st Internal financing = Internal financing is the first choice in pecking
order theory because there is no extra cost associated with using it. If a
company uses only retained earnings for financing, there is no cost of debt
or cost of equity to be accounted for.
 2nd Debt financing = Debt financing comes in second because of the interest
payments associated with using debt capital. Whether the company decides
to take out business loans or issue corporate bonds, they will have to pay
some interest, making the cost of debt more than the non-existent cost of
using retained earnings.
 3rd Equity financing = Equity financing is last in pecking order theory
because it is the most expensive financing option. The cost of equity capital
—for example, stock shares—is higher than the cost of debt financing.
Tax Shield
 Tax Shield
1. What is Tax Shield
 A tax shield is a reduction in taxable income for an
individual or corporation achieved through claiming
allowable deductions such as mortgage interest, medical
expenses, charitable donations, amortization, and
depreciation.
 These deductions reduce a taxpayer's taxable income for a
given year or defer income taxes into future years.
 Tax shields lower the overall amount of taxes owed by an
individual taxpayer or a business.
Clientele Effect Theory
 Clientele Effect Theory
1. What is Clientele Effect Theory
 The clientele effect theory states that different policies
attract different types of investors, and changes to the
policies will cause a shift in demand for the company’s
stock by investors, impacting its share price.
 In other words, the clientele effect is the existence of groups
of investors who are attracted to investing in companies
with specific policies
 Clientele Effect Theory
2. Example of Clientele Effect Theory
 Examples of two different clienteles can be retired
investors (those who may prefer stocks with a high
dividend payout) and young investors (those who may
prefer stocks that show strong capital appreciation).
 Once a company has established a set of policies, the
clientele effect highlights the importance of refraining
from making dramatic changes to such policies to prevent
a shift in clientele.
Market Timing Theory
 Market Timing Theory
1. Market Timing Theory Regarding Manager
 The Equity market timing can be defined as an attempt to
issue shares when their prices are high and repurchase them
in the opposite situation.
2. Market Timing Theory Regarding Investor
 Investor should purchase the share in such time in the stock
market when share prices are increasing
 Investor should sale the share in such time in the stock
market when share prices are decreasing