A main propose of the pecking order theory discuss in this paper can be briefly summarize as follows. When the asymmetric of information specifically on the firm's value exists, managers would use their informational advantage to issue stock only when they are overpriced, but investors rationally aware of management's incentive, would discount the price based on their expectation. This results a potential underinvestment problem, as managers might forego valuable investment opportunities. An implication of this theory is as follows:
1) To avoid the underinvestment problem, firms prefer to use internal funds first. When internal funds are insufficient, firms will turn to risk-free debt, then risky debt, and finally equity. This creates financial hierarchy rigidity and hence the name pecking order.
2) Asymmetric information could possibly be the source of financing costs. This opposes the convention that financing cost arose only from administrative and underwriting costs.
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