Ambiguity and capital structure adjustments

Mingyuan Ban and Chang-Chih Chen

International Review of Economics & Finance, 2019, vol. 64, issue C, 242-270

Abstract: We examine how ambiguity aversion affects firms’ capital structure adjustment policy by considering pricing-kernel ambiguity due to market incompleteness. In the model managers hold the worst-case belief about the risk-adjusted expected EBIT growth rate, causing upward (downward) distortion of default (restructuring) probability. This key feature makes firms display a weaker willingness to readjust leverage with choosing a slower pace and a smaller size of adjustment, which resolves the leverage inertia puzzle. Dynamic restructurings under ambiguity aversion generate a limited effect on leverage choice. The effectiveness of ambiguity aversion in explaining the low-leverage puzzle is superior to that of dynamic restructurings.

Keywords: Ambiguity aversion; Capital structure adjustment; Leverage inertia; Dynamic restructurings; Market incompleteness (search for similar items in EconPapers)
JEL-codes: G32 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:64:y:2019:i:c:p:242-270

DOI: 10.1016/j.iref.2019.05.009

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