Fighting Fire with Gasoline: CoCos in Lieu of Equity

Journal of Money, Credit and Banking

33 Pages Posted: 1 Aug 2016 Last revised: 21 Sep 2020

See all articles by Roman Goncharenko

Roman Goncharenko

KU Leuven - Department of Accountancy, Finance and Insurance (AFI)

Date Written: September 20, 2020

Abstract

In this paper, I theoretically examine the ability of Contingent Convertible bonds (CoCos), a source of bank capital under Basel III, to reduce the bank’s default risk. Although issuing CoCos adds a buffer to the bank’s balance sheet, it may induce wrong incentives in the form of debt overhang and risk shifting. My results indicate that the most popular type of CoCos, temporary write-down (TWD), is least effective at mitigating default risk. Unlike other types of CoCos, TWDs continue affecting shareholders’ incentives even after the trigger event, thereby, inducing an earlier endogenous default.

Keywords: Basel III, CoCos, Contingent Convertibles, Debt Overhang, Risk Shifting, Temporary Write-Downs

JEL Classification: G21, G28, G32

Suggested Citation

Goncharenko, Roman, Fighting Fire with Gasoline: CoCos in Lieu of Equity (September 20, 2020). Journal of Money, Credit and Banking, Available at SSRN: https://ssrn.com/abstract=2816133 or http://dx.doi.org/10.2139/ssrn.2816133

Roman Goncharenko (Contact Author)

KU Leuven - Department of Accountancy, Finance and Insurance (AFI) ( email )

Naamsestraat 69
Box 3525
Leuven, 3000
Belgium

HOME PAGE: http://sites.google.com/view/roman-goncharenko

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