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Shareholder risk-taking incentives in the presence of contingent capital

Mahmoud Fatouh () and Ayowande McMunn ()
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Mahmoud Fatouh: Bank of England, Postal: Bank of England, Threadneedle Street, London, EC2R 8AH
Ayowande McMunn: Carmihnac Asset Managers

No 775, Bank of England working papers from Bank of England

Abstract: This paper presents a model of shareholders’ willingness to exert effort to reduce the likelihood of bank distress, and the implications of the presence of contingent convertible (CoCo) bonds in the liabilities structure of a bank. Consistent with the existing literature, we show that the direction of the wealth transfer at the conversion of CoCo bonds determines their impact on shareholder risk-taking incentives. We also find that ‘anytime’ CoCos (CoCo bonds trigger-able anytime at the discretion of managers) have a minor advantage over regulator CoCo bonds, and that quality of capital requirements can reduce the risk-taking incentives of shareholders. We argue that shareholders can also use manager-specific CoCo bonds to reduce the riskiness of the bank activities. The issuance of such bonds can increase the resilience of individual banks and the whole banking system. Regulators can use restrictions on conversion rates and/or requirements on the quality of capital to address the impact of CoCo bonds issuance on risk-taking incentives.

Keywords: Risk-taking; CoCo bonds; anytime CoCos; quality of capital requirements; additional Tier 1 capital (AT1); bank manager compensation packages; compensation policy. (search for similar items in EconPapers)
JEL-codes: D81 G21 G28 G30 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-rmg
Date: 2019-01-18
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