The pecking order theory of capital structure rests on an assumption of: 1

Finance Dec 18, 2020

The pecking order theory of capital structure rests on an assumption of:

1. Agency costs

2. Barriers to entry

3. Asymmetric information

4. Tax shields cost of financial distress

Expert Solution

The correct answer is (3) Asymmetric information

According to the pecking order theory, the cost of financing business activity is influenced by asymmetric information. In specific, this theory postulates that the cost of finances increases with asymmetric information. Therefore, pecking order theory rest on assumption of asymmetric information. For this reason, the firm will prefer internal sources of capital before outsourcing capital.

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