IDEAS home Printed from https://ideas.repec.org/a/eee/reveco/v51y2017icp354-369.html
   My bibliography  Save this article

Growth option, contingent capital and agency conflicts

Author

Listed:
  • Tan, Yingxian
  • Yang, Zhaojun

Abstract

This paper examines how contingent convertible bonds (CoCos) outstanding impact on expansion investment under exogenous and endogenous conversion threshold. We provide a relatively formal method to price general corporate securities. We find that under an exogenous conversion threshold, there is a conversion ratio, i.e. a fraction of equity allocated to CoCos' holders upon conversion, such that underinvestment is eliminated. With a sufficiently high conversion ratio, issuing CoCos can alleviate and even eliminate the inefficiencies arising from debt overhang and asset substitution. However, under endogenous conversion, CoCos will conversely exacerbate the investment distortion, no mater how much the conversion ratios are.

Suggested Citation

  • Tan, Yingxian & Yang, Zhaojun, 2017. "Growth option, contingent capital and agency conflicts," International Review of Economics & Finance, Elsevier, vol. 51(C), pages 354-369.
  • Handle: RePEc:eee:reveco:v:51:y:2017:i:c:p:354-369
    DOI: 10.1016/j.iref.2017.06.006
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1059056017304847
    Download Restriction: Full text for ScienceDirect subscribers only

    File URL: https://libkey.io/10.1016/j.iref.2017.06.006?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    2. Suresh Sundaresan & Neng Wang & Jinqiang Yang, 2015. "Dynamic Investment, Capital Structure, and Debt Overhang," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 4(1), pages 1-42.
    3. Emilio Barucci & Luca Del Viva, 2013. "Dynamic capital structure and the contingent capital option," Annals of Finance, Springer, vol. 9(3), pages 337-364, August.
    4. Dandan Song & Zhaojun Yang, 2016. "Contingent Capital, Real Options, and Agency Costs," International Review of Finance, International Review of Finance Ltd., vol. 16(1), pages 3-40, March.
    5. Dirk Hackbarth & David C. Mauer, 2012. "Optimal Priority Structure, Capital Structure, and Investment," The Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 747-796.
    6. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    7. Avinash K. Dixit & Robert S. Pindyck, 1994. "Investment under Uncertainty," Economics Books, Princeton University Press, edition 1, number 5474.
    8. Pennacchi, George & Vermaelen, Theo & Wolff, Christian C. P., 2014. "Contingent Capital: The Case of COERCs," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 49(3), pages 541-574, June.
    9. Hilscher, Jens & Raviv, Alon, 2014. "Bank stability and market discipline: The effect of contingent capital on risk taking and default probability," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 542-560.
    10. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    11. 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.
    12. Lyandres, Evgeny & Zhdanov, Alexei, 2014. "Convertible debt and investment timing," Journal of Corporate Finance, Elsevier, vol. 24(C), pages 21-37.
    13. Mauer, David C. & Sarkar, Sudipto, 2005. "Real options, agency conflicts, and optimal capital structure," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1405-1428, June.
    14. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    15. Zhaojun Yang & Chunhong Zhang, 2015. "The Pricing of Two Newly Invented Swaps in a Jump-Diffusion Model," Annals of Economics and Finance, Society for AEF, vol. 16(2), pages 371-392, November.
    16. Paul Glasserman & Behzad Nouri, 2012. "Contingent Capital with a Capital-Ratio Trigger," Management Science, INFORMS, vol. 58(10), pages 1816-1833, October.
    17. Tan, Yingxian & Yang, Zhaojun, 2016. "Contingent capital, capital structure and investment," The North American Journal of Economics and Finance, Elsevier, vol. 35(C), pages 56-73.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. 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).
    2. Pengfei Luo & Zhaojun Yang, 2021. "Investment and financing for cash flow discounted with group diversity," International Review of Finance, International Review of Finance Ltd., vol. 21(3), pages 769-785, September.
    3. 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.
    4. Linjia Dong & Zhaojun Yang, 2022. "An Algorithm for the Pricing and Timing of the Option to make a Two-Stage Investment with Credit Guarantees," Computational Economics, Springer;Society for Computational Economics, vol. 60(3), pages 1175-1196, October.
    5. Song, Dandan & Luo, Pengfei & Yang, Jingjing, 2020. "Investment and capital structure decisions with strategic debt service under asymmetric information," The North American Journal of Economics and Finance, Elsevier, vol. 54(C).
    6. Dong, Linjia & Yang, Zhaojun, 2023. "Investment and financing analysis for a venture capital alternative," Economic Modelling, Elsevier, vol. 126(C).
    7. Luo, Pengfei & Song, Dandan & Chen, Biao, 2020. "Investment and financing for SMEs with bank-tax interaction and public-private partnerships," International Review of Economics & Finance, Elsevier, vol. 65(C), pages 163-172.
    8. Chen, Biao & Jiang, Jinglu & Zhu, Nanhui, 2023. "Optimal capital structure and credit policy with bank-tax-guarantee," Finance Research Letters, Elsevier, vol. 58(PA).
    9. Tan, Yingxian & Luo, Pengfei, 2021. "The impact of debt restructuring on dynamic investment and financing policies," Economic Modelling, Elsevier, vol. 102(C).
    10. Zhaojun Yang, 2020. "Investment and asset securitization with an option‐for‐guarantee swap," European Financial Management, European Financial Management Association, vol. 26(4), pages 1006-1030, September.
    11. Yanping Cai & Zhaojun Yang & Zhiming Zhao, 2019. "Contingent capital with repeated interconversion between debt‐ and equity‐like instruments," European Financial Management, European Financial Management Association, vol. 25(2), pages 358-379, March.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Tan, Yingxian & Yang, Zhaojun, 2016. "Contingent capital, capital structure and investment," The North American Journal of Economics and Finance, Elsevier, vol. 35(C), pages 56-73.
    2. Yanping Cai & Zhaojun Yang & Zhiming Zhao, 2019. "Contingent capital with repeated interconversion between debt‐ and equity‐like instruments," European Financial Management, European Financial Management Association, vol. 25(2), pages 358-379, March.
    3. Zhaojun Yang, 2020. "Investment and asset securitization with an option‐for‐guarantee swap," European Financial Management, European Financial Management Association, vol. 26(4), pages 1006-1030, September.
    4. 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.
    5. Agliardi, Elettra & Amel-Zadeh, Amir & Koussis, Nicos, 2016. "Leverage changes and growth options in mergers and acquisitions," Journal of Empirical Finance, Elsevier, vol. 37(C), pages 37-58.
    6. Berg, Tobias & Kaserer, Christoph, 2015. "Does contingent capital induce excessive risk-taking?," Journal of Financial Intermediation, Elsevier, vol. 24(3), pages 356-385.
    7. Bolton, Patrick & Wang, Neng & Yang, Jinqiang, 2019. "Investment under uncertainty with financial constraints," Journal of Economic Theory, Elsevier, vol. 184(C).
    8. Luo, Pengfei & Yang, Zhaojun, 2017. "Real options and contingent convertibles with regime switching," Journal of Economic Dynamics and Control, Elsevier, vol. 75(C), pages 122-135.
    9. Myklebust, Tor Åge, 2012. "Performance Sensitive Debt - Investment and Financing Incentives," Discussion Papers 2012/7, Norwegian School of Economics, Department of Business and Management Science.
    10. Xiaolin Wang & Zhaojun Yang & Pingping Zeng, 2023. "Pricing contingent convertibles with idiosyncratic risk," International Journal of Economic Theory, The International Society for Economic Theory, vol. 19(3), pages 660-693, September.
    11. Pengfei Luo & Zhaojun Yang, 2021. "Investment and financing for cash flow discounted with group diversity," International Review of Finance, International Review of Finance Ltd., vol. 21(3), pages 769-785, September.
    12. Tan, Yingxian & Luo, Pengfei, 2021. "The impact of debt restructuring on dynamic investment and financing policies," Economic Modelling, Elsevier, vol. 102(C).
    13. Koussis, Nicos & Martzoukos, Spiros H., 2022. "Credit line pricing under heterogeneous risk beliefs," International Journal of Production Economics, Elsevier, vol. 243(C).
    14. Li, Jay Y. & Mauer, David C., 2016. "Financing uncertain growth," Journal of Corporate Finance, Elsevier, vol. 41(C), pages 241-261.
    15. Himmelberg, Charles P. & Tsyplakov, Sergey, 2020. "Optimal terms of contingent capital, incentive effects, and capital structure dynamics," Journal of Corporate Finance, Elsevier, vol. 64(C).
    16. Manuel Ammann & Kristian Blickle & Christian Ehmann, 2017. "Announcement Effects of Contingent Convertible Securities: Evidence from the Global Banking Industry," European Financial Management, European Financial Management Association, vol. 23(1), pages 127-152, January.
    17. Morellec, Erwan & Schürhoff, Norman, 2011. "Corporate investment and financing under asymmetric information," Journal of Financial Economics, Elsevier, vol. 99(2), pages 262-288, February.
    18. Huang, Wenli & Liu, Bo & Wang, Hongli & Yang, Jinqiang, 2019. "Dynamic optimal investment policy under incomplete information," The North American Journal of Economics and Finance, Elsevier, vol. 50(C).
    19. Luo, Pengfei & Song, Dandan & Chen, Biao, 2020. "Investment and financing for SMEs with bank-tax interaction and public-private partnerships," International Review of Economics & Finance, Elsevier, vol. 65(C), pages 163-172.
    20. 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).

    More about this item

    Keywords

    Growth option; Contingent capital; Agency conflicts;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:reveco:v:51:y:2017:i:c:p:354-369. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/620165 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.