Contingent Capital: The Case of COERCs

54 Pages Posted: 16 Mar 2012

See all articles by Christian C. P. Wolff

Christian C. P. Wolff

University of Luxembourg; Centre for Economic Policy Research (CEPR)

George Pennacchi

University of Illinois

Theo Vermaelen

INSEAD - Finance; European Corporate Governance Institute (ECGI)

Multiple version iconThere are 3 versions of this paper

Date Written: March 15, 2012

Abstract

This paper introduces, analyzes, and values a new form of contingent convertible (CoCo), a Call Option Enhanced Reverse Convertible (COERC). Issued as a bond, it converts to new shareholders’ equity if a bank’s market value of capital falls below a pre-specified trigger. The COERC avoids the problems with market based triggers such as 'death spirals' as a result of manipulation or panic. A bank that issues COERCs also has a smaller incentive to choose investments that are subject to large losses. Furthermore, COERCs reduce the problem of 'debt overhang,' the disincentive to replenish shareholders’ equity following a decline. The low risk of COERCS should increase their appeal to risk-averse bondholders.

Keywords: crisis, banks, recapitalization, reverse convertible

JEL Classification: G20, G32, G33

Suggested Citation

Wolff, Christian C. P. and Pennacchi, George G. and Vermaelen, Theo, Contingent Capital: The Case of COERCs (March 15, 2012). AFA 2013 San Diego Meetings Paper, Available at SSRN: https://ssrn.com/abstract=2023009 or http://dx.doi.org/10.2139/ssrn.2023009

Christian C. P. Wolff (Contact Author)

University of Luxembourg ( email )

6, rue Richard Coudenhove-Kalergi
Kirchberg Campus
Luxembourg, South 1359
Luxembourg

Centre for Economic Policy Research (CEPR)

London
United Kingdom

George G. Pennacchi

University of Illinois ( email )

4041 BIF, Box 25
515 East Gregory Drive
Champaign, IL 61820
United States
217-244-0952 (Phone)

HOME PAGE: http://https://giesbusiness.illinois.edu/profile/george-pennacchi

Theo Vermaelen

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
33 1 60 72 42 63 (Phone)
33 1 60 72 40 45 (Fax)

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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