Does Debt Curb Controlling Shareholders’ Private Benefits? Modelling in a Contingent Claim Framework

Debt is not frequently analyzed in relation to the conflict between controlling and outside shareholders. At the same time, debt leverage stands as a key variable in the design of a control contract as it has a strong disciplinary role. A simple option valuation model is used to show that debt is also a governance variable because it can moderate or enhance private benefits. It is argued that a asymmetrical self-regulation mechanism may develop in the case of control by a dominant shareholder. At low levels of leverage, debt is relatively less disciplinary compared with a non-private benefits case. When leverage exceeds a certain threshold point, it becomes strongly disciplinary. We show that under given conditions, a self-regulation mechanism develops where the controlling shareholder is incentivized to hold less debt when he/she wants to increase his/her private appropriation rate.