Corporate Financial Dynamics: A Pecking-Order Approach

Abstract

This paper shows that combining an upper constraint on dividends, a lower constraint on dividends due to shareholder preferences, and an interest rate that increases with the debt ratio leads to a pecking-order financial structure: A typical firm will start to finance a new investment by issuing new shares in combination with debt, then grow by financing its investments with retained earnings and borrowing, and eventually stop growing and distribute all profits. Repurchases of shares will speed up this growth path. Economic depreciation may make the firm want to stop the decline in its capital stock earlier.