Contingent Capital, Real Options, and Agency Costs

38 Pages Posted: 3 Mar 2016

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: March 2016

Abstract

This paper aims to clarify how contingent convertible bond (CoCo) as a debt financing instrument affects a firm's investment policy, agency cost of debt, and capital structure. We consider endogenous and exogenous conversion thresholds, respectively. Under the exogenous case, there is an explicit optimal fraction of equity allocated to CoCo holders upon conversion, such that the agency cost reaches zero. Numerical analysis demonstrates that under an endogenous conversion threshold, CoCo induces 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.

Suggested Citation

Song, Dandan and Yang, Zhaojun, Contingent Capital, Real Options, and Agency Costs (March 2016). International Review of Finance, Vol. 16, Issue 1, pp. 3-40, 2016, Available at SSRN: https://ssrn.com/abstract=2741370 or http://dx.doi.org/10.1111/irfi.12076

Dandan Song (Contact Author)

Hunan University - School of Finance and Statistics ( email )

School of Finance and Statistics
Changsha, CA 410079
China

Zhaojun Yang

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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