This paper provides a model to analyze a recently documented empirical phenomenon, the investors’ simultaneous holding of equity and debt stakes in one firm. The model formalizes the idea that the existence of a dual holder could effectively reconcile the conflicts between debt holders and shareholders and improve firm values. We argue that the dual holder’s risk-shifting incentive could be eliminated when her debt-equity ratio exceeds some threshold, which is dependent on the ownership structure of the firm. Moreover, the existence of a dual holder could be considered as a credible commitment on ‘no-risk-shifting’ behaviors only if the dual holder has the power to enforce her preferred decisions ex post. Further, we show that the dual holder’s debt stake will increase her incen...[ Read more ]

This paper provides a model to analyze a recently documented empirical phenomenon, the investors’ simultaneous holding of equity and debt stakes in one firm. The model formalizes the idea that the existence of a dual holder could effectively reconcile the conflicts between debt holders and shareholders and improve firm values. We argue that the dual holder’s risk-shifting incentive could be eliminated when her debt-equity ratio exceeds some threshold, which is dependent on the ownership structure of the firm. Moreover, the existence of a dual holder could be considered as a credible commitment on ‘no-risk-shifting’ behaviors only if the dual holder has the power to enforce her preferred decisions ex post. Further, we show that the dual holder’s debt stake will increase her incentive to exert effort and improve the firm value, but it might impair the other pure equity holders’ incentive to input efforts. The relative importance of the ‘Effort-Inducing’ effect on the dual holder compared with the ‘Effort-Reducing’ effect on the pure equity holders is decreasing in the ownership concentration degree of the pure equity holders.