Dallas Business Consultant Elijah ClarkDallas Business Consultant Elijah Clark

Taxonomy of Leadership Theories

Taxonomy of Leadership Theories

in my next blogs, I haveĀ reviewed and evaluated the nature of leadership styles and their theories. My post summarizes findings from research on authentic leadership, leader-member exchange, servant leadership, and situational leadership. Examples of a servant leader and situational leader were integrated as a framework to show how the different theories can be viewed in a real case scenario.

Researchers have discovered that, by serving and supporting organizational members, leaders can create a positive and productive environment (Cubero, 2007; Avolio,Ā Walumbwa, & Weber,Ā 2009; Liden, Wayne, Liao, & Meuser, 2014). Leadership style plays a role in followers’ perceptions of an organization. The leadership style is often more important that the leaders opinion (Cubero, 2007). By satisfying followers through listening to their needs, adapting to their situation, creating a positive exchange, and building trust, leaders and followers together will have the tools needed to create and innovate within the organization (Hassanzadeh, 2014)

The study of leadership spans more than 100 years McCleskey (2014). Leadership has gained attention of researchers worldwide (Northouse, 2013). Leadership style influences followers, and it is an important component of a leader (Cubero, 2007). Leadership research has conceptualized leadership as being an extraordinary ability of certain individuals (McCleskey, 2014). MyĀ postĀ will focus on four concepts of leadership: servant, authentic, situation, and leader-manager exchange. The next blog postĀ begins with authentic leadership.

 

 

Trade-off and Pecking-order Theories

Trade-off and Pecking-order Theories
A profitable company requires less need for external financing. To satisfy financial needs, firms will often turn to debt. A profitable company usually relies on less debt. However, according to the trade-off theory, the more cash flow a profitable firm has, the more debt it will generate. As the debt capacity accumulates, it will be used to capture tax shields and leverage benefits.Ā Within the trade-off theory, managers seek optimal capital structure. Trade-off theory translates into empirical hypothesis as it predicts a relationship between average debt ratios and asset risk, profitability, tax status, and asset type. The pecking order theory has no optimally well-defined debt ratio. Financial distress is not a concern for the pecking order theory, and tax shields are a more attractive method to use according to the model.

The pecking order theory is built on the struggles of obtaining cost efficient financing. The theory suggests that managers should use bonds because they are a lesser risk for stock price declines. Considering firms know they will need cash within the future to manage profitable projects, they accumulate the cash today, so they will not have to forcibly go to capital markets when financing is needed. Nonetheless, because of the additional cash, managers are tempted to purchase and will likely generate wasteful spending on activities.

Pecking order theory explains the variances of debt ratios, rather than the target adjustment model based on static trade-off theory. The pecking order theory can be rejected if financing flows with the target-adjustments specified. However, the trade-off theory may appear to work, which will create false positive results from time patterns of capital expenses, which creates reverting debt ratios.

Applicable Industries
Pecking order is unlikely to do well for companies investing into intangible assets. Trade-off theory works well withinĀ industries that have room for growth and expansion. Mature industries that can practically predict their future like Coca-Cola have nothing to lose by using external funds.Ā In 2014 The Coca-Cola Company (Coke) had a long-term debt of $19,063 million and a net income of $45,998 million. The debt ratio at Coke is optimal and is maximizing its market capitalization value at their debt levels. The company has a long-term debt of less than one year’s current net earnings. Consequently, a single year earnings can pay the debt.

Intel is a company that follows the pecking order theory, particularly because of its high-risk industry. Although the company is large, considering the technology industry is forever changing at a rapid pace, the company struggles to remain relevant, which creates the industry to be high risk. Because of the large market and competition, the company has to create innovative products and quickly get them to market. This causes a problem by not allowing revenue to fund the company’s growth, and the firm has to rely on debt to satisfy the market.

In addition to the theories, capital structure is beneficial as it presents the type of financing a firms uses. The mixture of methods includes equity and debt. To determine the right type of capital structure, firms often use a combination of debt and equity in order to maximize their market value. With leverage, a firm can lower its weighted average cost of capital. However, leverage increases financial risk of firms that must service their debt regularly. Trade-off theory helps determine the most optimal debt-to-equity ratio. Pecking-order theory allows for firms to finance themselves through retained earnings. When there are no retained earnings, the firm issues debt, and as a last resort may issue equity. Debt informs investors that management is confident with servicing the debt, and equity signals that the firm may be overvalued and could trigger a stock price fall. In regards to management, pecking-order theory suggests capital structure is rooted to agency theory and suggest that financial decisions are affected by the firms’ attempt to minimize shareholder supervision. Pecking-order theory seems to focus on examining the financial behaviors of larger firms, which have a larger borrowing capacity.

Trade-off theory focuses on bankruptcy cost and debt, which states there are advantages to debt financing. Pecking-order theory focuses on financing from internal funds, and using external funds as a last resort. Trade-off theory has dominated corporate finance circles. The pecking-order theory assumes there is no capital structure. Additionally, pecking-order can easily be applied to small firms considering smaller firms borrow based on their needs rather than optimal capital structure. Increased financial leverage affects a company’s WACC. With financial leverage, the company’s WACC decreases until optimal debt ratio is achieved, after which, the WACC rises with more debt. Increasing the debt of the capital structure also increases the tax benefits considering the interest is tax deductible. The company’s market capitalization is increased when WACC is decreased considering trade-off theory assumes the company’s risk of bankruptcy.

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