Ambiguity and the Tradeoff Theory of Capital Structure

• Main Authors: Izhakian, Y. (Author), Yermack, D. (Author), Zender, J.F (Author)
• Format: Article
• Language: English
• Published: INFORMS Inst.for Operations Res.and the Management Sciences 2022
• Subjects: Ambiguity averse; Ambiguity aversion; Ambiguity index; Ambiguity measure; Capital structure; Capital Structure; Decision theory; Knightian uncertainty; Leverage; Operations research; Perceived probabilities; Perceived probability; Theory model
• Online Access: View Fulltext in Publisher

 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. Copyright: © 2021 INFORMS