Contingent Convertible Bonds and Capital Structure Decisions
45 Pages Posted: 1 May 2016
Date Written: December 14, 2015
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
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