Coverage of financing deficit in firms in financial distress under the pecking order theory

The fi nancing decisions adopted by fi rms in fi nancial distress are very important because most of the strategy decisions such as investments, market entry, or product diversifi cation are considerably affected by the fi nancial constraints faced by them.However, these decisions are still not well known and empirical evidence about fi rms in fi nancial distress is controversial.Previous studies do not fi nd support for either the trade-off theory or the pecking order theory, which explain the fi nancial decisions of healthy fi rms.Distressed fi rms frequently have to use all of their available fi nancial resources to cover their fi nancing defi cit.This could give rise to a concave quadratic relationship between fi nancing defi cit and net debt issued, which might well explain the ambivalent results about the fi nancial decisions of these fi rms.To analyze this quadratic relationship, which has not been studied previously, we perform an empirical analysis on a sample of 3,337 listed fi rms 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 fi rms.Moreover, the hierarchy suggested by the pecking order theory is not totally applicable in fi rms in fi nancial distress.Our results show that as fi nancing defi cit grows, these fi rms use debt decreasingly, which gives rise to a concave quadratic relationship between fi nancing defi cit and net debt issued.This suggests that fi rms in fi nancial distress have diffi culty issuing new debt.Our results also show that fi rms in fi nancial distress have a greater probability of issuing equity.Therefore, these fi rms can use equity fi nancing as an alternative to debt issuance.