Contingent Convertible Bonds: Payoff Structures and Incentive Effects

Kenjiro Hori and Jorge Martin Cerón
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Jorge Martin Cerón: Birkbeck, University of London

No 1711, Birkbeck Working Papers in Economics and Finance from Birkbeck, Department of Economics, Mathematics & Statistics

Abstract: This paper analyses two aspects of contingent convertible (CoCo) bonds. First, we establish and compare in detail the payoff structures of the following different bail-out/in schemes: no bail-out/in, government bail-out, equity-conversion CoCo bail-in and write-down / write-off CoCo bail-in. This reveals that the equityholders progressively gain extra incremental "put-spread"or "condor-like" option structures at each step of the bail-out/in schemes in the order listed. Second, we investigate two types of agency costs, namely the wealth-transfer problem and the value destruction problem. We show that these are aggravated under equity-conversion CoCo bail-ins, and are even higher under write-off CoCo bail-in for larger asset values, suggesting inherent structural incentive issues associated with these bonds. We then analyse CoCo bail-in as a non-admissible debt-to-equity swap (DES), and argue that agency costs are worse than for the admissible DES.

Keywords: CoCo bond; bail-in; agency cost; incentives. (search for similar items in EconPapers)
JEL-codes: D82 G21 G28 G32 (search for similar items in EconPapers)
Date: 2017-11
New Economics Papers: this item is included in nep-cfn
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https://eprints.bbk.ac.uk/id/eprint/25371 First version, 2017 (application/pdf)

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