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    Abstract:

    This paper considers the effect of ambiguity on optimal capital structure with a subsidy to investment in combination with a taxation of future profits. It is shown that it might be optimal for the government to provide an investment subsidy when the current tax rate is lower and to provide a tax cut when current tax rate is higher. In addition, quantitative analysis displays that the presence of model uncertainty reduces firm value, raises credit spread, and leads to deleveraging. However, agency costs decrease when decisionmakers are concerned about ambiguity. From this standpoint, our model provides a behavioral justification for the higher financing cost and zero leverage for small and medium enterprises.

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  • Online: January 20,2025
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