Contingent Convertible Bonds and Capital Structure Decisions

45 Pages Posted: 1 May 2016

See all articles by Boris Albul

Boris Albul

University of California, Berkeley - Haas School of Business

Dwight M. Jaffee

University of California, Berkeley - Finance Group; National Bureau of Economic Research (NBER)

Alexei Tchistyi

University of Illinois at Urbana-Champaign - Department of Finance

Date Written: December 14, 2015

Abstract

This paper provides a formal model of contingent convertible bonds (CCBs), debt instruments that automatically convert to equity if and when the issuing firm or bank reaches a specified level of financial distress. We develop closed-form solutions for the value of CCBs with market-based conversion triggers and show that under certain conditions on CCB parameters, the equilibrium is unique. We also show that CCBs can increase firm value and reduce the chance of costly bankruptcy or bailout if properly implemented. Nonetheless, shareholders of overleveraged or too-big-to-fail firms may resist straight debt-for-CCB swaps due to the debt overhang effect or the loss of the government subsidy. CCBs can also create incentives to manipulate the stock market when the conversion value of the CCB is too low or too high.

Keywords: contingent convertible bonds, CoCos

Suggested Citation

Albul, Boris and Jaffee, Dwight M. and Tchistyi, Alexei, Contingent Convertible Bonds and Capital Structure Decisions (December 14, 2015). Available at SSRN: https://ssrn.com/abstract=2772612 or http://dx.doi.org/10.2139/ssrn.2772612

Boris Albul

University of California, Berkeley - Haas School of Business ( email )

545 Student Services Building, #1900
2220 Piedmont Avenue
Berkeley, CA 94720
United States

Dwight M. Jaffee

University of California, Berkeley - Finance Group ( email )

Haas School of Business
545 Student Services Building
Berkeley, CA 94720
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Alexei Tchistyi (Contact Author)

University of Illinois at Urbana-Champaign - Department of Finance ( email )

1206 South Sixth Street
Champaign, IL 61820
United States

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