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Contingent Convertibles with Stock Price Triggers: The Case of Perpetuities

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  • George Pennacchi
  • Alexei Tchistyi

Abstract

Initial proposals for contingent convertibles (CoCos) envisioned that these bonds would convert to equity when the issuing bank’s stock price declined to a prespecified trigger. Subsequent research has claimed that doing so causes the stock price to have multiple equilibria or no equilibrium. We show that when CoCos are perpetuities, which characterizes most actual CoCos, a unique stock price equilibrium exists, except under unrealistic conditions. Unique equilibria occur when conversion favors or disfavors CoCo investors, when CoCos convert to equity or are written down, and when CoCos are callable. We also analyze a bank’s risk choices before and after conversion. Received November 29, 2016; editorial decision July 15, 2018 by Editor Itay Goldstein.

Suggested Citation

  • George Pennacchi & Alexei Tchistyi, 2019. "Contingent Convertibles with Stock Price Triggers: The Case of Perpetuities," The Review of Financial Studies, Society for Financial Studies, vol. 32(6), pages 2302-2340.
    • Handle: RePEc:oup:rfinst:v:32:y:2019:i:6:p:2302-2340.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhy092
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    Cited by:

    1. Avdjiev, Stefan & Bogdanova, Bilyana & Bolton, Patrick & Jiang, Wei & Kartasheva, Anastasia, 2020. "CoCo issuance and bank fragility," Journal of Financial Economics, Elsevier, vol. 138(3), pages 593-613.
    2. Koziol, Christian & Roßmann, Philipp, 2022. "Contingent convertible bonds: Optimal call strategy and the impact of refinancing," Journal of Corporate Finance, Elsevier, vol. 77(C).
    3. Ambrocio, Gene & Hasan, Iftekhar & Jokivuolle, Esa & Ristolainen, Kim, 2020. "Are bank capital requirements optimally set? Evidence from researchers’ views," Journal of Financial Stability, Elsevier, vol. 50(C).
    4. Javadi, Siamak & Li, Weiping & Nejadmalayeri, Ali, 2023. "Contingent capital conversion under dual asset and equity jump–diffusions," International Review of Financial Analysis, Elsevier, vol. 89(C).
    5. Anne G. Balter & Nikolaus Schweizer & Juan C. Vera, 2020. "Contingent Capital with Stock Price Triggers in Interbank Networks," Papers 2011.06474, arXiv.org.
    6. Mendes, Layla dos Santos & Leite, Rodrigo de Oliveira & Fajardo, José, 2022. "Do contingent convertible bonds reduce systemic risk?," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 78(C).
    7. Yang, Bo & Gan, Liu, 2021. "Contingent capital, Tobin’s q and corporate capital structure," The North American Journal of Economics and Finance, Elsevier, vol. 55(C).
    8. McWalter, Thomas A. & Ritchken, Peter H., 2022. "Black economic empowerment regulation and risk incentives," Journal of Economic Dynamics and Control, Elsevier, vol. 139(C).
    9. Michael Sigmund & Kevin Zimmermann, 2021. "Determinants of Contingent Convertible Bond Coupon Rates of Banks: An Empirical Analysis (Michael Sigmund, Kevin Zimmermann)," Working Papers 236, Oesterreichische Nationalbank (Austrian Central Bank).
    10. Gupta, Aparna & Wang, Runzu & Lu, Yueliang, 2021. "Addressing systemic risk using contingent convertible debt – A network analysis," European Journal of Operational Research, Elsevier, vol. 290(1), pages 263-277.

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