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Contingent Capital: The Case for COERCs

Author

Listed:
  • Christian Wolff

    (Luxembourg School of Finance, University of Luxembourg)

  • Theo Vermaelen

    (INSEAD)

  • George Pennacchi

    (University of Illinois at Urbana Champaign)

Abstract

In this paper we propose a new security, the Call Option Enhanced Reverse Convertible (COERC). The security is a form of contingent capital, i.e. a bond that converts into equity when the market value of equity relative to debt falls below a certain trigger. The conversion price is set significantly below the trigger price and, at the same time, equity holders have the option to buy back the shares from the bondholders at the conversion price. Compared to other forms of contingent capital proposed in the literature, the COERC is less risky in a world where bank assets can experience sudden jumps. Moreover, the structure eliminates concerns about putting the company in a “death spiral” as a result of manipulation or panic. A bank that issues COERCs also has a smaller incentive to choose investments that are subject to large losses.

Suggested Citation

  • Christian Wolff & Theo Vermaelen & George Pennacchi, 2010. "Contingent Capital: The Case for COERCs," LSF Research Working Paper Series 10-08, Luxembourg School of Finance, University of Luxembourg.
    • Handle: RePEc:crf:wpaper:10-08
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    References listed on IDEAS

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    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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