COVERAGE OF FINANCING DEFICIT IN FIRMS IN FINANCIAL DISTRESS UNDER THE PECKING ORDER THEORY
Name and surname of author:
Sergio Sanﬁlippo-Azofra, Carlos López-Gutiérrez, Begoña Torre-Olmo
Capital structure, ﬁnancial distress, pecking order
DOI (& full text):
The ﬁnancing decisions adopted by ﬁrms in ﬁnancial distress are very important because most of the strategy decisions such as investments, market entry, or product diversiﬁcation are considerably…more
The ﬁnancing decisions adopted by ﬁrms in ﬁnancial distress are very important because most of the strategy decisions such as investments, market entry, or product diversiﬁcation are considerably affected by the ﬁnancial constraints faced by them. However, these decisions are still not well known and empirical evidence about ﬁrms in ﬁnancial distress is controversial. Previous studies do not ﬁnd support for either the trade-off theory or the pecking order theory, which explain the ﬁnancial decisions of healthy ﬁrms. Distressed ﬁrms frequently have to use all of their available ﬁnancial resources to cover their ﬁnancing deﬁcit. This could give rise to a concave quadratic relationship between ﬁnancing deﬁcit and net debt issued, which might well explain the ambivalent results about the ﬁnancial decisions of these ﬁrms. To analyze this quadratic relationship, which has not been studied previously, we perform an empirical analysis on a sample of 3,337 listed ﬁrms from Germany, Canada, the United States, France, Italy and the United Kingdom. Our results show that the pecking order theory does not appear to have a higher explanatory power in healthy ﬁrms. Moreover, the hierarchy suggested by the pecking order theory is not totally applicable in ﬁrms in ﬁnancial distress. Our results show that as ﬁnancing deﬁcit grows, these ﬁrms use debt decreasingly, which gives rise to a concave quadratic relationship between ﬁnancing deﬁcit and net debt issued. This suggests that ﬁrms in ﬁnancial distress have difﬁculty issuing new debt. Our results also show that ﬁrms in ﬁnancial distress have a greater probability of issuing equity. Therefore, these ﬁrms can use equity ﬁnancing as an alternative to debt issuance.