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Title:The firm under uncertainty: capital structure and background risk PDF Logo
Authors:Broll, Udo
Wong, Keith K.P.
Issue Date:2010
Series/Report no.:Dresden discussion paper series in economics 04/10
Abstract:This paper examines the interplay between the real and financial decisions of the competitive firm under output price uncertainty. The firm faces additional sources of uncertainty that are aggregated into a 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 underlying uncertainty. We further show that the firm's optimal input mix depends on its optimal debt-equity ratio, thereby rendering the interdependence of the real and financial decisions of the firm. When the background risk is either additive or multiplicative, we provide reasonable restrictions on the firm's preferences so as to ensure that the firm's optimal output is adversely affected upon the introduction of the background risk.
Subjects:Background risk
Capital structure
Price uncertainty
JEL:D21
D81
G32
Document Type:Working Paper
Appears in Collections:Dresden Discussion Paper Series in Economics, Faculty of Business and Economics, TU Dresden

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