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Ambiguity and capital structure adjustments

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  • Ban, Mingyuan
  • Chen, Chang-Chih

Abstract

We examine how ambiguity aversion affects firms’ capital structure adjustment policy by considering pricing-kernel ambiguity due to market incompleteness. In the model managers hold the worst-case belief about the risk-adjusted expected EBIT growth rate, causing upward (downward) distortion of default (restructuring) probability. This key feature makes firms display a weaker willingness to readjust leverage with choosing a slower pace and a smaller size of adjustment, which resolves the leverage inertia puzzle. Dynamic restructurings under ambiguity aversion generate a limited effect on leverage choice. The effectiveness of ambiguity aversion in explaining the low-leverage puzzle is superior to that of dynamic restructurings.

Suggested Citation

  • Ban, Mingyuan & Chen, Chang-Chih, 2019. "Ambiguity and capital structure adjustments," International Review of Economics & Finance, Elsevier, vol. 64(C), pages 242-270.
    • Handle: RePEc:eee:reveco:v:64:y:2019:i:c:p:242-270
    DOI: 10.1016/j.iref.2019.05.009
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    2. Yehuda Izhakian & David Yermack & Jaime F. Zender, 2022. "Ambiguity and the Tradeoff Theory of Capital Structure," Management Science, INFORMS, vol. 68(6), pages 4090-4111, June.

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    More about this item

    Keywords

    Ambiguity aversion; Capital structure adjustment; Leverage inertia; Dynamic restructurings; Market incompleteness;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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