A rational justification of the pecking order hypothesis to the choice of sources of financing

Abstract

Developed by Stewart Myers (1984), the pecking order theory has turned out to be a spotlight in the recent trend of shifting from the traditional static trade‐off optimal model to other theories as an effort to look for an explanation of corporate capital structure behaviour. This article proposes a rational justification to the pecking order hypothesis through the establishment of its relationship to the paradox Modigliana‐Miller proposition I. In the process of reasoning to support our justification, we have resorted to various existing theoretical hypothesis including tax‐shelter theory, bankruptcy costs theory, agency theory, signalling theory, and managerial risk aversion theory. Some implications of this rational justification to the pecking order hypothesis are also briefly discussed.