Question

What is the sequence of strategies used to source both equity and debt capital globally? Should a firm start by sourcing global debt or equity?

Answer 1

The sequence in which the capital is sourced from different sources is explained by the pecking order theory. The pecking order theory says that managers prefer internal financing over external financing as it gives them more freedom to operate. So, if a manager requires fund for investment purposes then the first sources of capital, they prefer to use is the retained earnings, using retained earning presents less obstacle for managers and if they still need funds then they go for external financing. Even within the external financing managers prefer to have debt over equity. The cost of debt is lower than the cost of equity so manager first uses the debt source and then uses equity to raise funds as the required return on equity is higher than the cost of debt. Normally when a company is just starting its business getting loan or debt from any source is very difficult because for debt you need the financial performance so most firms when starting they go for equity but once the business has been in its operation for sometime and doing well then they uses a combination of debt and equity where they can maximize the returns to equity shareholders.