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Contingent Convertible Bonds: Payoff Structures and Incentive Effects

Author

Listed:
  • Kenjiro Hori

    (Birkbeck, University of London)

  • Jorge Martin Cerón

    (Birkbeck, University of London)

Abstract

This paper analyses two aspects of contingent convertible (CoCo) bonds. First, we establish and compare in detail the payoff structures of the following different bail-out/in schemes: no bail-out/in, government bail-out, equity-conversion CoCo bail-in and write-down / write-off CoCo bail-in. This reveals that the equityholders progressively gain extra incremental "put-spread"or "condor-like" option structures at each step of the bail-out/in schemes in the order listed. Second, we investigate two types of agency costs, namely the wealth-transfer problem and the value destruction problem. We show that these are aggravated under equity-conversion CoCo bail-ins, and are even higher under write-off CoCo bail-in for larger asset values, suggesting inherent structural incentive issues associated with these bonds. We then analyse CoCo bail-in as a non-admissible debt-to-equity swap (DES), and argue that agency costs are worse than for the admissible DES.

Suggested Citation

  • Kenjiro Hori & Jorge Martin Cerón, 2017. "Contingent Convertible Bonds: Payoff Structures and Incentive Effects," Birkbeck Working Papers in Economics and Finance 1711, Birkbeck, Department of Economics, Mathematics & Statistics.
    • Handle: RePEc:bbk:bbkefp:1711
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    File URL: https://eprints.bbk.ac.uk/id/eprint/25371
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    References listed on IDEAS

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    Cited by:

    1. Giovanni Calice & Carlo Sala & Daniele Tantari, 2020. "Contingent Convertible Bonds in Financial Networks," Papers 2009.00062, arXiv.org, revised Dec 2023.
    2. Philippe Oster, 2020. "Contingent Convertible bond literature review: making everything and nothing possible?," Journal of Banking Regulation, Palgrave Macmillan, vol. 21(4), pages 343-381, December.

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    More about this item

    Keywords

    CoCo bond; bail-in; agency cost; incentives.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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