Fixed Prices and Regulatory Discretion as Triggers for Contingent Capital Conversion: An Experimental Examination

30 Pages Posted: 13 Aug 2015

See all articles by Douglas D. Davis

Douglas D. Davis

Virginia Commonwealth University - School of Business - Department of Economics

Edward S. Prescott

Federal Reserve Banks - Federal Reserve Bank of Cleveland

Date Written: 2015-03-02

Abstract

An unresolved issue regarding the implementation of 'contingent capital' bonds regards identifying the best mechanism for triggering the conversion of debt into equity. This paper reports a laboratory experiment that builds on previous work to evaluate the relative desirability of two leading candidate mechanisms: a price informed regulator and a mechanistic fixed-price trigger. We find that the conversion rule in effect determines the desirability of these two mechanisms. When the conversion increases incumbent equity value, a fixed trigger is preferable, but when the conversion decreases value, the reverse holds. Two modifications for improving the regulator mechanism, creating regulator bias (e.g., giving a regulator asymmetric rewards over intervention) and probabilistically providing a regulator with non-market information, only enhance this result.

JEL Classification: C92, G14, G28

Suggested Citation

Davis, Douglas D. and Prescott, Edward (Ned) Simpson, Fixed Prices and Regulatory Discretion as Triggers for Contingent Capital Conversion: An Experimental Examination (2015-03-02). FRB Richmond Working Paper No. 15-02. Available at SSRN: https://ssrn.com/abstract=2643138 or http://dx.doi.org/10.2139/ssrn.2643138

Douglas D. Davis (Contact Author)

Virginia Commonwealth University - School of Business - Department of Economics ( email )

Box 844000
Richmond, VA 23284-4000
United States

Edward (Ned) Simpson Prescott

Federal Reserve Banks - Federal Reserve Bank of Cleveland ( email )

P.O. Box 6387
Cleveland, OH 44101
United States

HOME PAGE: http://https://www.clevelandfed.org/people-search?pid=f8ca941e-4b51-41f6-95f8-c87f1d3806e5

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