Contingent Capital: The Case for COERCs

46 Pages Posted: 22 Nov 2010

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: September 2010

Abstract

In this paper we propose a new security, the Call Option Enhanced Reverse Convertible (COERC). The security is a form of contingent capital, i.e. a bond that converts into equity when the market value of equity relative to debt falls below a certain trigger. The conversion price is set significantly below the trigger price and, at the same time, equity holders have the option to buy back the shares from the bondholders at the conversion price. Compared to other forms of contingent capital proposed in the literature, the COERC is less risky in a world where bank assets can experience sudden jumps. Moreover, the structure eliminates concerns about putting the company in a “death spiral” 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.

Keywords: Banks, Financial crisis, Financial stability, Security design

JEL Classification: G01, G20

Suggested Citation

Pennacchi, George G. and Vermaelen, Theo and Wolff, Christian C. P., Contingent Capital: The Case for COERCs (September 2010). CEPR Discussion Paper No. DP8028, Available at SSRN: https://ssrn.com/abstract=1711021

George G. Pennacchi (Contact Author)

University of Illinois ( email )

4041 BIF, Box 25
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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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