EconPapers    
Economics at your fingertips  
 

Corporate bond clawbacks as contingent capital for banks

Fernando Díaz, Gabriel Ramirez and Liuling Liu

Journal of Financial Stability, 2018, vol. 37, issue C, 11-24

Abstract: We propose a contingent clawback bond (COCLA) as an alternative source of contingent convertible capital (CoCo). We develop a utility maximization model in which a bank manager faces the following two trade-offs: one trade-off is between the private benefits of control and costs of financial distress when loans under-perform, and the other is between the costs and benefits of screening loan credit quality (effort). In our model, the supply of loans, amount of junior debt issued, level of effort exerted by a manager, and manager's decision to exercise the clawback option are endogenously determined in the maximization of the manager's utility function. We find that the manager optimally exercises the clawback following a low realization of cash flows, thereby solving the trigger problem presented in CoCos. In the model, the debt to equity conversion from the COCLA is an endogenous decision, the regulatory capital adequacy ratio (CAR) is satisfied, and the bank does not face distress costs. From a practical perspective, the conversion rate for the COCLA that jointly maximizes the manager's expected utility and stock holders’ pay offs is around 25%, a rate close to the typical percentage (30%–35%) that is often found in initial public offering clawback (IPOC) contracts used in the corporate world.

Keywords: IPO; Clawbacks; Contingent capital; CoCos; Financial stability (search for similar items in EconPapers)
JEL-codes: G2 G1 (search for similar items in EconPapers)
Date: 2018
References: View references in EconPapers View complete reference list from CitEc
Citations: Track citations by RSS feed

Downloads: (external link)
http://www.sciencedirect.com/science/article/pii/S1572308918300913
Full text for ScienceDirect subscribers only

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:37:y:2018:i:c:p:11-24

Access Statistics for this article

Journal of Financial Stability is currently edited by I. Hasan, W. C. Hunter and G. G. Kaufman

More articles in Journal of Financial Stability from Elsevier
Bibliographic data for series maintained by Dana Niculescu ().

 
Page updated 2019-03-31
Handle: RePEc:eee:finsta:v:37:y:2018:i:c:p:11-24