The theory that managers may prefer internal sources of funds to the lowest cost source of funds is known as
A) the Modigliani and Miller Proposition.
B) tradeoff theory.
C) financial stress avoidance theory.
D) pecking order theory.

Question

Quizplus · Accepted Answer

The theory that managers may prefer internal sources of funds to the lowest cost source of funds is known as pecking order theory. This theory suggests that firms have a hierarchy of financing sources, and they prefer to use internal funds first, followed by debt, and finally equity as a last resort. This preference is due to information asymmetry between managers and outside investors, which can lead to adverse selection problems if the firm were to issue new equity or debt. Therefore, the pecking order theory suggests that managers may choose to use internal funds even if external funds are available at a lower cost.

The Theory That Managers May Prefer Internal Sources of Funds