On the Cash-Flow and Control Rights of Contingent Capital

Abstract

Partial conversion of contingent capital (CC) provides its owners with a portfolio of equity
and debt. Since equity (debt) typically induces a preference for risk taking (safety), the net
preference of CC-holders upon conversion will depend on their relative holdings of each asset,
which in turn, depends on the amount of CC converted. Conversions also provide CC-holders
with equity control rights; this may induce shareholders to: 1) dilute their equity stakes by
selecting high-risk portfolios, thereby creating risk-loving and in uential CC-holders; or 2) fore-
stall the creation of in uential and safety-loving CC-holders by selecting low-risk portfolios. The
quantitative results suggest that CC on the order of 8-10.5% of total bank assets can rule-out
high-risk equilibria in most cases.

Keywords: Contingent Capital, Bank Regulation, Corporate Governance.

JEL Classification: G21, G28, G34