Pecking Order Theory and the Financial Structure Of

The principal objective in this paper is to ascertain the extent to which Myers’ (1984) Pecking Order Theory (POT) of business financing appears to explain financial structure amongst a panel of 871 manufacturing SMEs legally organised as proprietary companies, taken from the Australian federal government’s Business Longitudinal Survey for three financial years from 1995-96 to 1997-98. The research findings reported in the paper provide further substantial empirical evidence broadly suggesting pecking order financing behaviour amongst SMEs. However, the findings also suggest the need for a modified POT that more fully reflects the special circumstances and nuances of SME financing. A full specification for a modified POT of financing for SMEs is proposed as a basis for further inquiry in the area. Introduction Concerning the extent to which extant theories of financing appear to explain the financial structure of business concerns, Pettit and Singer (1985, p. 54) argue: Business firms of all sizes select their financial structure in view of the cost, nature, and availability of financial alternatives. For a number of reasons, our understanding of this decision for large and small firms is deficient. In addition, Pettit and Singer (1985, p. 58) posit that the ‘level of debt and equity in a smaller firm is more than likely a function of the characteristics of the firm and its managers’. Levin and Travis (1987, p. 30) provide support for this view, suggesting: In the private corporation, leverage theory doesn’t always apply. The owners’ attitudes towards personal risk – not the capital structuring policies public companies use – determine what amounts of debt and equity are acceptable. Finally, McMahon et al. (1993, p. 244) reason that: Given the initial failure of modern finance theory to provide normative and practicable guidance on making financial structure decisions in business enterprises generally, and particularly in small enterprises, the only alternative is to seek for a positive theory. The continued absence of a widely accepted normative theory of financial structure for business enterprises thus underscores the importance of developing and testing the veracity of positive theories of business financing like the so-called Pecking Order Theory ( POT). The following outline of the POT of business financing is provided by Myers (1984, p. 581): • Firms prefer internal finance.