Contingent Capital, Real Options and Agency Costs

32 Pages Posted: 6 Aug 2013 Last revised: 12 Nov 2014

See all articles by Dandan Song

Dandan Song

Hunan University - School of Finance and Statistics

Zhaojun Yang

Southern University of Science and Technology - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: June 4, 2014

Abstract

This paper aims to clarify how contingent convertible bond (CCB) as a debt financing instrument affects the firm's investment policy, agency cost of debt and capital structure. We consider two different conversion thresholds of CCB: One is endogenous and the other is exogenous. We find that under an exogenous conversion threshold, there is an explicit optimal fraction of equity allocated to CCB holders upon conversion, such that the agency cost reaches the minimum value zero. Numerical analysis demonstrates that CCB decreases bankruptcy risk and increases the issuing firm value. Under an endogenous conversion threshold, CCB gives rise to overinvestment, a higher leverage, a possible bigger agency cost and a stronger incentive to increase risk. But if the conversion threshold is exogenously determined, almost the opposite holds true.

Keywords: real options, contingent convertible bond, capital structure, agency costs

JEL Classification: G13, G32

Suggested Citation

Song, Dandan and Yang, Zhaojun, Contingent Capital, Real Options and Agency Costs (June 4, 2014). Available at SSRN: https://ssrn.com/abstract=2306623 or http://dx.doi.org/10.2139/ssrn.2306623

Dandan Song

Hunan University - School of Finance and Statistics ( email )

School of Finance and Statistics
Changsha, CA 410079
China

Zhaojun Yang (Contact Author)

Southern University of Science and Technology - Department of Finance ( email )

No 1088, Xueyuan Rd.
District of Nanshan
Shenzhen, Guangdong 518055
China

HOME PAGE: http://faculty.sustc.edu.cn/profiles/yangzj

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