Contingent Capital: The Case of COERCs
54 Pages Posted: 16 Mar 2012
Date Written: March 15, 2012
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.
Keywords: crisis, banks, recapitalization, reverse convertible
JEL Classification: G20, G32, G33
Suggested Citation: Suggested Citation