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 an asymmetrical self-regulation mechanism may develop in the case of control by a dominant shareholder. The joint questions of control, private benefits, and debt levels are linked within an inside corporate governance framework. At low levels of leverage, debt is relatively less disciplinary compared with a non-private benefits case. When leverage exceeds a 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.