Final answer:
Firms utilize retained earnings for capital because it does not dilute shareholders' equity or incur underwriting and administrative costs associated with issuing new common stock. Only when retained earnings are insufficient do they consider issuing new stock, which is expensive and introduces new stakeholders.The answer to the question is true.
Step-by-step explanation:
The statement that firms will raise all the common equity they can from retained earnings before issuing new common stock is true. Retained earnings refer to the portion of net income which is retained by the company rather than distributed to its shareholders as dividends. Utilizing retained earnings as a source of capital does not involve issuing new equity, thus no dilution occurs to the existing shareholders' stakes, and there are no underwriting fees associated with public offerings. Furthermore, retained earnings do not require a firm to give up any additional control of the company.
When retained earnings are inadequate for the firm's capital needs, it may need to turn to external sources like borrowing through banks or bonds, or by issuing new common stock. Issuing new common stock can be more expensive due to factors such as underwriting fees, administrative costs, and the broader impact on the company's ownership structure. It may dilute the existing shareholders' equity and introduces more stakeholders into the company's decision-making process. Therefore, companies generally prefer using retained earnings before resorting to new equity financing.