Ambiguity and the Tradeoff Theory of Capital Structure

Management Science

69 Pages Posted: 21 Nov 2016 Last revised: 8 Mar 2021

See all articles by Yehuda (Yud) Izhakian

Yehuda (Yud) Izhakian

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance

David Yermack

New York University (NYU) - Stern School of Business

Jaime F. Zender

University of Colorado at Boulder - Department of Finance

Date Written: May 19, 2017

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 provides 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: Capital Structure, Ambiguity measure, Ambiguity aversion

JEL Classification: C65, D81, D83, G32

Suggested Citation

Izhakian, Yehuda (Yud) and Yermack, David and Zender, Jaime F., Ambiguity and the Tradeoff Theory of Capital Structure (May 19, 2017). Management Science, Available at SSRN: https://ssrn.com/abstract=2873248 or http://dx.doi.org/10.2139/ssrn.2873248

Yehuda (Yud) Izhakian

City University of New York, Baruch College - Zicklin School of Business - Department of Economics and Finance ( email )

17 Lexington Avenue
New York, NY 10010
United States

HOME PAGE: http://people.stern.nyu.edu/yizhakia/

David Yermack (Contact Author)

New York University (NYU) - Stern School of Business ( email )

44 West 4th Street
Suite 9-160
New York, NY 10012-1126
United States
212-998-0357 (Phone)
212-995-4220 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~dyermack

Jaime F. Zender

University of Colorado at Boulder - Department of Finance ( email )

Boulder, CO 80309
United States
303-554-1665 (Phone)
303-492-4689 (Fax)

HOME PAGE: http://www-bus.colorado.edu/faculty/Zender/

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