The Agency of CoCos: Why Contingent Convertible Bonds Aren't for Everyone

60 Pages Posted: 11 Nov 2017 Last revised: 26 Mar 2019

See all articles by Roman Goncharenko

Roman Goncharenko

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

Steven Ongena

University of Zurich - Department of Banking and Finance; Swiss Finance Institute; KU Leuven; Centre for Economic Policy Research (CEPR)

Asad Rauf

Vienna Graduate School of Finance (VGSF)

Date Written: March 21, 2019

Abstract

Most regulators grant contingent convertible bonds (CoCos) the status of equity. Theory, however, suggests that CoCos can induce debt overhang, thereby, reducing the bank’s incentive to issue fresh equity. In this paper, we examine the debt overhang problem of CoCos. First, we theoretically investigate how the extent of this debt overhang varies with bank characteristics. Our model predicts that banks with higher asset volatility face higher debt overhang from CoCos. Next, we analyze a comprehensive database of CoCo issuance. We find that banks with higher asset volatility are less likely to issue CoCos than those with safer assets. Since under the current regulatory framework of Basel III banks are expected to raise equity prior to CoCo conversion, riskier banks that anticipate equity issuance are less likely to issue CoCos before.

Keywords: CoCos, Contingent Convertible Bonds, Bank Capital Structure, Debt Overhang, Basel III

JEL Classification: G01, G12, G24

Suggested Citation

Goncharenko, Roman and Ongena, Steven R. G. and Rauf, Asad, The Agency of CoCos: Why Contingent Convertible Bonds Aren't for Everyone (March 21, 2019). Available at SSRN: https://ssrn.com/abstract=3067909 or http://dx.doi.org/10.2139/ssrn.3067909

Roman Goncharenko

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

Steven R. G. Ongena (Contact Author)

University of Zurich - Department of Banking and Finance ( email )

Schönberggasse 1
Zürich, 8001
Switzerland

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Asad Rauf

Vienna Graduate School of Finance (VGSF) ( email )

Welthandelsplatz 1
Building D4, 4th Floor
Vienna, Vienna 1020
Austria

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