Universität des Saarlandes
University of Saarland
Volkswirtschaftliche Reihe
Economic Series
CAPITAL STRUCTURE, AND THE FIRM
UNDER UNCERTAINTY
Udo BROLL and Kit Pong WONG
Economic Series No. 9909
May 1999
University of Saarland
Department of Economics (FB 2)
P.O. Box 151 150
D-66041 SAARBRUECKEN, GERMANY
Phone: +49-681-302 -4353, Fax:-4390
http://www.iwb.uni-sb.de
E-mail: [email protected]
Abstract
This paper examines the interplay between the real and financial decisions of the competitive
firm à la Sandmo. Besides output price uncertainty, the firm faces additional sources of risk
which are aggregated into an additive background risk. We show that the firm always chooses its
optimal debt-equity ratio to minimize the weighted average cost of capital, irrespective of the risk
attitude of the firm and the incidence of the multiple sources of uncertainty. Even though the introduction of the background risk affects neither the optimal debt-equity ratio nor the marginal
rate of technical substitution, it does have an adverse effect on the output level of the firm. Furthermore, if capital is a normal input, the presence of the background risk induces the firm to
acquire less capital by issuing less debt and equity.
JEL Codes: D81, G32.
Keywords: Background risk, Capital structure, Price uncertainty.
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Volkswirtschaftliche Reihe/Economic Series
Prof. Dr. Hermann ALBECK
Nationalökonomie, insbesondere Wirtschaftsund Sozialpolitik
http://www.uni-sb.de/rewi/fb2/albeck/
Prof. Dr. Jürgen EICHBERGER
Nationalökonomie, insbesondere Wirtschaftstheorie
http://www.uni-sb.de/rewi/fb2/eichberger/
Prof. Dr. Ralph FRIEDMANN
Statistik und Ökonometrie
http://www.wiwi.uni-sb.de/friedmann/
Prof. Dr. Robert HOLZMANN
Nationalökonomie, insbesondere Internationale
Wirtschaftsbeziehungen
http://www.wiwi.uni-sb.de/lst/iwb/
http://www.wiwi.uni-sb.de/lst/iwb/
PD Dr. Udo BROLL
Prof. Dr. Christian KEUSCHNIGG
Nationalökonomie, insbesondere Finanzwissenschaft
http://www.wiwi.uni-sb.de/fiwi/
Prof. Dr. Dr. h.c. Rudolf RICHTER
Nationalökonomie, insbesondere Wirtschaftstheorie
http://www.uni-sb.de/rewi/fb2/eichberger/richter/home-eng.htm
Prof. Dr. Dieter SCHMIDTCHEN
Nationalökonomie, insbesondere Wirtschaftspolitik
http://www.uni-sb.de/rewi/fb2/schmidtchen/
Prof. Dr. Volker STEINMETZ
Statistik und Ökonometrie
http://www.uni-sb.de/rewi/fb2/steinmetz/
9901 Christian KEUSCHNIGG
Rationalization and Specialization in Start-up
Finanzwissenschaft
Investment
9902 Jürgen EICHBERGER
Non-Additive Beliefs and Strategic Equilibria
David KELSEY
Economic Theory
9903 Jürgen EICHBERGER
Education Signalling and Uncertainty
David KELSEY
Economic Theory
9904 Christian KEUSCHNIGG
Eastern Enlargement of the EU:
Wilhelm KOHLER
How Much is it Worth for Austria?
Finanzwissenschaft
9905 Aymo BRUNETTI
More Open Economies Have Better Governments
Beatrice WEDER
Internationale Wirtschaftsbeziehungen
9906 Ralph FRIEDMANN
Markus GLASER
Statistik und Ökonometrie
9907 Rudolf RICHTER
Economic Theory
9908 Rudolf RICHTER
Economic Theory
9909 Udo BROLL
Kit Pong WONG
International Economics
Effects Of The Order Of Entry On Market Share,
Trial Penetration, And Repeat Purchases: Empirical
Evidence Or Statistical Artefact ?
A Note on the Transformation of Economic Systems
European Monetary Union: Initial Situation, Alter
natives, Prospects - -in the Light of Modern Institutional Economics
Capital structure, and the firm under uncertainty