Ambiguity and the Tradeoff Theory of Capital Structure
43 Pages Posted: 21 Nov 2016 Last revised: 20 May 2017
Date Written: May 19, 2017
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.
Keywords: Capital Structure, Ambiguity measure, Ambiguity aversion
JEL Classification: C65, D81, D83, G32
Suggested Citation: Suggested Citation