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

42 Pages Posted: 11 Nov 2017 Last revised: 19 Sep 2018

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: September 13, 2018

Abstract

Most regulators grant contingent convertible bonds (CoCos) the status of equity. Theory however suggests that these securities can distort incentives via inducing debt overhang and risk shifting. In this paper we therefore theoretically model how the degree of this distortion varies with bank risk. Our model predicts that riskier banks face higher debt overhang from CoCos. Next, analyzing a comprehensive database of CoCo issuance in Europe, we empirically test the predictions of our model. We find that banks with lower risk are more likely to issue CoCos than their riskier counterparts. Since in the current regulatory framework of Basel III banks are expected to raise equity prior to CoCo conversion, future debt overhang makes CoCos an expensive source of capital. Thus, riskier banks will opt for equity issuance over CoCos.

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 (September 13, 2018). 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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