 On the design of bail-in-able bonds from the perspective of non-financial firmsLiang-Chih Liu, Tian-Shyr Dai and Lei Zhou International Review of Economics & Finance, 2024, vol. 89, issue PA, 1136-1155 Abstract: To prevent black swan events such as the financial tsunami or COVID-19 from crashing overall economic systems, governments provide bailouts to too-big-to-fail financial institutions and non-financial firms such as airline companies with tax payers’ money. To avoid unfair bailouts, using bail-in-able bonds to absorb an issuing bank’s losses and to fulfill capital requirements such as BASEL III has been widely studied. Without capital adequacy requirements, non-financial firms also issue bail-in-able bonds because the embedded loss-absorbing mechanism can cut debt repayments down to reduce bankruptcy risk and thus increase the overall benefits of these firms’ claim holders. However, bond investors require higher rewards to compensate for their potential losses once this mechanism is triggered. In addition, unlike financial institutions, which are strictly regulated, such a mechanism may induce non-financial issuers to take on excessive risk to benefit themselves at the expense of their debt holders. To investigate how the issuances of various (non)-bail-in-able bonds influence the equity and the existing debt holders’ benefits from a non-financial issuer’s prospective, we develop novel quadrature pricing formulas based on the structural credit risk model. We find that while non-bail-in-able bonds can be wise choices for low-leverage issuers, bail-in-able bonds with benefit-sharing mechanisms allowing investors to share issuers’ upside profits can efficiently suppress interest expenses and circumvent the asset substitution problem for high-leverage issuers. If the value of an issuer (such as an oil shale firm) mainly depends on the value of that asset (such as oil), issuing a bail-in-able bond referring to the asset could be a wise choice. Otherwise, issuing a bond referring to the issuer’s stock price could provide timely fund injections and low interest expenses for a high-leverage public firm. Keywords: Bail-in-able bond; Contingent capital; Asset substitution problem; Structural credit risk model (search for similar items in EconPapers) Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:eee:reveco:v:89:y:2024:i:pa:p:1136-1155 DOI: 10.1016/j.iref.2023.07.098 Access Statistics for this article International Review of Economics & Finance is currently edited by H. Beladi and C. Chen More articles in International Review of Economics & Finance from Elsevier |
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