Contingent Convertibles with Stock Price Triggers: The Case of Perpetuities

George Pennacchi and Alexei Tchistyi

The Review of Financial Studies, 2019, vol. 32, issue 6, 2302-2340

Abstract: Initial proposals for contingent convertibles (CoCos) envisioned that these bonds would convert to equity when the issuing bank’s stock price declined to a prespecified trigger. Subsequent research has claimed that doing so causes the stock price to have multiple equilibria or no equilibrium. We show that when CoCos are perpetuities, which characterizes most actual CoCos, a unique stock price equilibrium exists, except under unrealistic conditions. Unique equilibria occur when conversion favors or disfavors CoCo investors, when CoCos convert to equity or are written down, and when CoCos are callable. We also analyze a bank’s risk choices before and after conversion. Received November 29, 2016; editorial decision July 15, 2018 by Editor Itay Goldstein.

Date: 2019
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The Review of Financial Studies is currently edited by Itay Goldstein

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