The following paragraphs explain what is in the mind of the managers when they decide whether to use the Pecking Order Model or the Trade -off Model are used.
Myers (1984) stated that the company’s managers have to exert all efforts to maintain the status quo in their dealings with the market. Thus, many the managers prefer to apply the pecking order theory than the trade off model in seeking additional funds to be used in their business operations (Scott, 1972.p. 45-50). The pecking order means that the company prioritises generating funds from internal sources. These internal sources include the net income or retained earnings from operations, dividend withheld from its stockholders (Baskin, 1989. pp. 26-35). If this choice is not possible, then the second source of income is borrowing money (Marsh, 1982. p. 121-144). The lenders become creditors and not owners of the company. If this second choice is also not possible, then the last choice would be to offer stocks to the public so that new investment money will flow in (Bradley, Jarrell and Kim, 1984.pp. 857-878).
To reiterate, the pecking order is the preferred choice of many managers because they do not want to go through the rigours of having to place themselves under the scrutiny and investigative discipline the law when money is borrowed such as the banks request for a feasibility study to determine if the company will be able to pay their loans when the due date arrives (Ferri and Jones, 1979.pp. 631-644). Likewise, the company will not have to go through the difficulty of submitting to the stock exchanges and the government regulating agencies the reasons for their planned offering of stocks to the market (Mikkelson and Partch, 1986.p.31-60).
But in this occurs, then the company would rather offer preferred stocks before offering the common stocks the public. For the common stock gives the investors the right to vote in the management’s business plans. Whereas, most preferred stocks do not permit the stockholders to vote in the management plans. For, many managers abhor the presenting of confidential financial statements to the lenders and general public when stocks are offered in the exchanges (Myers and Majluf, 1984. p. 187-221).
For, the pecking order shows that generating funds associates the gearing ratio to the company’s retained earnings which is the accumulation of the yearly net income of the company and distribution or withholding of dividends to the stockholders on record and the offer of stocks to the general public in stock exchanges (Jalivland and Harris, 1984.p.127-145).
Reasonably, management will prefer to pay dividends to their stockholders and expand its business operations through additional investment from its current stockholders on record instead of offering new stocks to the general public who are complete strangers to the company (Taggart,1977.p.1467-1484). For, internally generated money will do away with the usual problems and obstacles when external money is chosen as a fund source. Furthermore, externally -generated funds like bonds and long term bank loans could place an additional requirement that all company business decisions in terms of expansion or closing down shop will have to be approved by the