Give a detailed definition of Pecking Order Hypothesis and T

Give a detailed definition of Pecking Order Hypothesis and Tradeoff Theory hypothesis and underlying assumptions.

Solution

Pecking Order Theory states that managers prefer financing choice that swnd the least visible signal to investers, witg internal capital being most preferred, debt being next, and raising equity externally the least preferred method.

Static trade off theory seeks to balance the costs of financial distress with tge tax shield benefits from using debt and states that there is an optimal capital structure that has an optimal proportion of debt.

The key assumption of Pecking theory is asymmetric information between Managers and share holders.

The assumption of Trade off theory is that there is a cost of financial distress. And there is an optimum level from where present value of financial distress will increase present value of tax shield of debt.

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