NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Ambiguity and the Tradeoff Theory of Capital Structure

Yehuda Izhakian, David Yermack, Jaime F. Zender

NBER Working Paper No. 22870
Issued in November 2016, Revised in May 2017
NBER Program(s):Corporate Finance

We examine the importance of ambiguity, or Knightian uncertainty, in the capital structure decision. We develop a static tradeoff theory model in which agents are both risk averse and ambiguity averse. The model confirms the usual idea that increased risk—the uncertainty over known possible outcomes—leads firms to use less leverage. Conversely, greater ambiguity—the uncertainty over the probabilities associated with the outcomes—leads firms to increase leverage. Using a theoretically motivated measure of ambiguity, our empirical analysis provides results consistent with these predictions.

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Document Object Identifier (DOI): 10.3386/w22870

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