Contingent Capital in Executive Compensation

Abstract

Contingent capital has great potential to improve corporate governance in Systemically Important Financial Institutions (SIFIs). Early initiatives by European SIFIs to include contingent convertible bonds in executive compensation packages lack governance improving designs. This article suggests the use of contingent convertible bonds with an early conversion trigger in executive compensation. The proposal adds an important element to the literature on inside debt and the creditor-centered approach to executive compensation. Contingent convertible bonds with early triggers could be preferable to other debt instruments because, in addition to lowering income inequality and increasing sustainability, the early trigger design can improve incentives for executives to lower risk taking, improve signaling of default risk, and increase incentives for monitoring by creditors and shareholders. The recognition of ownership characteristics in design features adds an important element to the literature on contingent capital trigger designs. The methodological assumptions of incomplete contract theory can improve the analysis of executive compensation arrangements.

Keywords: Executive Compensation, Contingent Capital, Corporate Governance, Trigger Designs