How does uncertainty influence target capital structure?

Abstract

This study investigates how uncertainty affects firms’ target capital structure using a panel data set of U.S. public manufacturers between 2003 and 2018 and finds that high-uncertainty firms have 10.1 (8.1) percentage points lower mean book (market) targets than low-uncertainty firms. This study also shows that the uncertainty effect on leverage targets is greater than the impact of firm size, market-to-book ratio, assets tangibility, R&D intensity, and industry median leverage, making uncertainty the most critical among all time-varying determinants of leverage targets. Further, this study finds that heightened uncertainty decreases debt tax shields, increases potential financial distress costs, and exacerbates debtholder–shareholder conflicts, thereby leading to a lower optimal or target leverage ratio.