Contingent Capital: The Case for COERCs

54 Pages Posted: 4 May 2011 Last revised: 23 Dec 2011

See all articles by George Pennacchi

George Pennacchi

University of Illinois

Theo Vermaelen

INSEAD - Finance

Christian C. P. Wolff

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

Multiple version iconThere are 3 versions of this paper

Date Written: December 23, 2011

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.

Suggested Citation

Pennacchi, George G. and Vermaelen, Theo and Wolff, Christian C. P., Contingent Capital: The Case for COERCs (December 23, 2011). INSEAD Working Paper No. 2011/133/FIN. Available at SSRN: https://ssrn.com/abstract=1656994 or http://dx.doi.org/10.2139/ssrn.1656994

George G. Pennacchi (Contact Author)

University of Illinois ( email )

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

HOME PAGE: http://www.business.illinois.edu/gpennacc/

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)

Christian C. P. Wolff

University of Luxembourg - Luxembourg School of Finance ( email )

4, rue Albert Borschette
Luxembourg, 1246
Luxembourg

HOME PAGE: http://www.lsf.lu

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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