Ambiguity and the Tradeoff Theory of Capital Structure
NBER Working Paper No. 22870
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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