Market‐Triggered Changes in Capital Structure: Equilibrium Price Dynamics

Paul Glasserman and Behzad Nouri

Econometrica, 2016, vol. 84, 2113-2153

Abstract: We analyze the internal consistency of using the market price of a firm's equity to trigger a contractual change in the firm's capital structure, given that the value of the equity itself depends on the firm's capital structure. Of particular interest is the case of contingent capital for banks, in the form of debt that converts to equity, when conversion is triggered by a decline in the bank's stock price. We analyze the problem of existence and uniqueness of equilibrium values for a firm's liabilities in this context, meaning values consistent with a market‐price trigger. Discrete‐time dynamics allow multiple equilibria. In contrast, we show that the possibility of multiple equilibria can largely be ruled out in continuous time, where the price of the triggering security adjusts in anticipation of breaching the trigger. Our main condition for existence of an equilibrium requires that the consequences of triggering a conversion be consistent with the direction in which the trigger is crossed. For the design of contingent capital with a stock price trigger, this condition may be interpreted to mean that conversion should be disadvantageous to shareholders, and it is satisfied by setting the trigger sufficiently high. Uniqueness follows provided the trigger is sufficiently accessible by all candidate equilibria. We illustrate precise formulations of these conditions with a variety of applications.

Date: 2016
References: Add references at CitEc
Citations: View citations in EconPapers (18)

Downloads: (external link)
http://hdl.handle.net/

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:wly:emetrp:v:84:y:2016:i::p:2113-2153

Ordering information: This journal article can be ordered from
https://www.economet ... ordering-back-issues

Access Statistics for this article

Econometrica is currently edited by Guido W. Imbens

More articles in Econometrica from Econometric Society Contact information at EDIRC.
Bibliographic data for series maintained by Wiley Content Delivery ().