Working Paper: NBER ID: w22870
Authors: Yehuda Izhakian; David Yermack; Jaime F. Zender
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: ambiguity; capital structure; tradeoff theory; risk aversion
JEL Codes: C65; D81; D83; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| ambiguity (D84) | perceived probabilities of future cash flows (G17) |
| perceived probabilities of future cash flows (G17) | increased debt financing (G32) |
| ambiguity (D84) | changes in leverage (G32) |
| greater risk (D81) | decreased leverage (G32) |
| greater ambiguity (D80) | increased leverage (G32) |