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Sweeting - Page 25, Section 3.2.3

T

Teacher's Pet

Member
Does any kind soul knows what is the reason behind this line?

"In particular, the 'pecking order' theory (POT) suggest that firms will be inclined to finance future opportunities with equity share capital so that profits from the investment are not captured by debtholders"

But a quick search on google explains that POT suggest issuance of debt is preferred over equity because it signals the company's capability of meeting the monthly obligation in debt repayment.

Appreciate any help on this, cheers!
 
Hi. I agree the "pecking order" reference seems slightly out of place. I understand that POT means companies use internal resources first, followed by debt and then fresh equity.

Bear in mind that "equity" is vague as it can refer to retained earnings (ie internal resources) or fresh capital (ie a rights issue).

POT breaks down a bit at high levels of gearing, ie if gearing is high (or a project is particularly risky) shareholders may be concerned that the company may get into difficulties and fail to service its debt obligations - perhaps only in the short term while there is still substantial potential value in the business long-term. At that point the debtholders would take over the company and would capture any upside left in the business. This seems to be the scenario Sweeting is referring to?
 
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