We develop a model of the interaction of firms' capital and ownership structures. The structures are designed to trade off managerial discipline versus managerial initiative. Debt features constrain managerial choice following poor firm performance. Equity ownership dispersion increases managerial initiative, by granting some managerial freedom following high firm performance. The empirical predictions are: equity ownership should be concentrated when debt is closely held, effective debt covenants are present, bankruptcy procedures and the institutional environment are creditor friendly, and board representation of lenders is commonplace. By contrast, equity should be dispersed if long‐term investments are more important than short‐term project selection.