Private Benefits in a Contingent Claim Framework: Valuation Effects and Other Implications

Abstract

This article extends the continuous time framework of the firm developed by Black, Scholes, and Merton to analyze effects of private benefits. We highlight first how straight private benefits can lower stakeholders’ wealth. We nevertheless point out that private benefits do not necessarily mean expropriation of minority equity holders. Managers can indeed adjust the business risk of the firm so as to make private benefits innocuous for equity. This in turn has a couple of beneficial consequences for blockholders. First, this prevents minority equity holders to complain for expropriation to authorities. Second, the portion of equity they have does not suffer from any value decrease. Innocuous private benefits cannot have however unlimited value, because the associated volatility would be unreasonable and too detrimental for bondholders. We also consider cases where managers enjoy a retirement plan and account for this in their strategic adjustment. Our simulations suggest that minority shareholders may take advantage of it. Finally, we advocate that covenants in loan contracts may prevent or limit such strategic behaviour.

Keywords: Agency theory, private benefits, tunneling, contingent claim analysis

JEL Classification: G12, G32, G33