Stabilizing Large Financial Institutions with Contingent Capital Certificates

33 Pages Posted: 30 Mar 2011

See all articles by Mark J. Flannery

Mark J. Flannery

University of Florida - Department of Finance, Insurance and Real Estate

Multiple version iconThere are 2 versions of this paper

Date Written: March 1, 2010

Abstract

Corporate limited liability tends to make firms under-value the possibility that their actions will have extremely bad outcomes. This distortion has been a particular focus for banking firms because their equity capital ratios are low and the government has an interest in assuring a stable financial system. This paper describes a novel security that large financial firms could issue in order to maintain their capital ratios above regulatory minima with a very high probability. “Contingent capital certificates” (CCC) would be issued as debt obligations, but would convert into common stock if the issuer’s capital ratio fell below some critical, pre-specified value. These bonds would add to the firm’s risk-bearing capacity in bad states of the world without burdening the firm with tax-inefficient equity financing in the good states

Suggested Citation

Flannery, Mark Jeffrey, Stabilizing Large Financial Institutions with Contingent Capital Certificates (March 1, 2010). CAREFIN Research Paper No. 04/2010. Available at SSRN: https://ssrn.com/abstract=1798611

Mark Jeffrey Flannery (Contact Author)

University of Florida - Department of Finance, Insurance and Real Estate ( email )

P.O. Box 117168
Gainesville, FL 32611
United States
352-392-3184 (Phone)
352-392-0103 (Fax)

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