The design of internal control and capital structure

We study the design of internal control and capital structure.We pose the question, When is control allocated only to shareholdersand when is it allocated to other stakeholders, such as debtholders,or the management team? We show that shareholders (debtholders)get control when the firm's cash flow is relatively sensitive(insensitive) to managerial effort. Our theory implies thatthe signs of the correlations between endogenous variables whenshareholders have absolute control are reversed when debtholdershave veto power. In particular, debt level and firm value arenegatively (positively) correlated when debtholders have vetopower (shareholders have absolute control).