Ambiguity and the Tradeoff Theory of Capital Structure

Yehuda Izhakian (), David Yermack () and Jaime F. Zender ()
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Yehuda Izhakian: Zicklin School of Business, Baruch College, New York, New York 10010
David Yermack: Stern School of Business, New York University, New York, New York 10012; National Bureau of Economic Research, Cambridge, Massachusetts 02138
Jaime F. Zender: Leeds School of Business, University of Colorado, Boulder, Boulder, Colorado 80309

Management Science, 2022, vol. 68, issue 6, 4090-4111

Abstract: We examine the impact of ambiguity, or Knightian uncertainty, on the capital structure decision, using a static tradeoff theory model in which agents are both ambiguity and risk averse. The model confirms the well-known result that greater risk—the uncertainty over outcomes—leads firms to decrease leverage. Conversely, the model indicates that greater ambiguity—the uncertainty over the probabilities associated with the outcomes—leads firms to increase leverage. Using a theoretically based measure of ambiguity, our empirical analysis presents evidence consistent with these notions, showing that ambiguity has an important and distinct impact on capital structure.

Keywords: Capital Structure; Leverage; Ambiguity aversion; Ambiguity measure; Ambiguity index; Perceived probabilities (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (6)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:6:p:4090-4111

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