When companies are on the verge of total collapse, they actually start playing it safe instead of taking big gambles to save themselves.
SSRN · March 17, 2026 · 6305980
The Takeaway
Standard economic theory predicts that near-bankrupt firms will take wild, reckless risks because they have nothing left to lose. This study finds that when managers face true 'ambiguity' (uncertainty about the future), they actually become hyper-cautious, overturning decades of assumptions about how distressed businesses behave.
From the abstract
We develop a dynamic capital structure model featuring downward jump shocks and costly external equity to quantify the impact of shareholder ambiguity aversion. We show that ambiguity fundamentally reshapes financial policy by eroding the firm's going-concern value, generating three distinct regimes. Under low ambiguity, firms actively recapitalize to avoid costly default. As ambiguity increases to moderate levels, the incentive to issue equity vanishes, and firms drift passively toward wipe-out