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Corporate Bond Clawbacks as Contingent Capital

  • Fernando Díaz


    (Facultad de Economía y Empresa, Universidad Diego Portales)

  • Gabriel Ramírez


    (Coles College of Business, Kennesaw State University)

  • Kenneth Daniels


    (Coles College of Business, Kennesaw State University)

We propose a clawback-type security (COCLA) as an alternative source of contingent capital for banks. We develop a equilibrium model that contains several distinctive features not found in the existing literature. A bank owner/manager maximizes her expected utility by choosing the bank’s loans supply and the amount of junior debt and by exercising effort to screen credit quality of borrowers. The manager has the choice to convert and the decision results from the trade off she faces between the private benefits of control and the expected costs of financial distress, thus, getting around the so called “trigger problem”. We show that the clawback conversion rate that maximizes the manager/owner expected utility, the level of her effort and amount of loans is 30%. Our model endogenizes many features of the actual decision problems faced by banks and provides for a security that is socially beneficial as the credit for consumers is increased when compared with the outcomes of simply using straight subordinated or convertible debt. The results of the model are robust and calibration of the model produces bank asset and debt structures that are very close to that of the average top 60 largest banks in the USA.

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Paper provided by Facultad de Economía y Empresa, Universidad Diego Portales in its series Working Papers with number 44.

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Date of creation: Sep 2013
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Handle: RePEc:ptl:wpaper:44
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  1. Pennacchi, George G. & Vermaelen, Theo & Wolff, Christian C, 2010. "Contingent Capital: The Case for COERCs," CEPR Discussion Papers 8028, C.E.P.R. Discussion Papers.
  2. Patrick Bolton & Frédéric Samama, 2012. "Capital access bonds: contingent capital with an option to convert," Economic Policy, CEPR;CES;MSH, vol. 27(70), pages 275-317, 04.
  3. George M. von Furstenberg, 2011. "Concocting Marketable Cocos," Working Papers 222011, Hong Kong Institute for Monetary Research.
  4. Edward Simpson Prescott, 2011. "Contingent capital: the trigger problem," Working Paper 11-07, Federal Reserve Bank of Richmond.
  5. Daniels, Kenneth N. & Hurtado, Fernando Díaz & Ramírez, Gabriel G., 2013. "An empirical investigation of corporate bond clawbacks (IPOCs): Debt renegotiation versus exercising the clawback option," Journal of Corporate Finance, Elsevier, vol. 20(C), pages 14-21.
  6. repec:fip:fedreq:y:2012:i:1q:p:33-50:n:vol.98no.1 is not listed on IDEAS
  7. Koziol, Christian & Lawrenz, Jochen, 2012. "Contingent convertibles. Solving or seeding the next banking crisis?," Journal of Banking & Finance, Elsevier, vol. 36(1), pages 90-104.
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