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

45 Pages Posted: 3 Dec 2018

See all articles by Roman Goncharenko

Roman Goncharenko

KU Leuven

Steven Ongena

University of Zurich - Department Finance; Swiss Finance Institute; KU Leuven; NTNU Business School; Centre for Economic Policy Research (CEPR)

Asad Rauf

University of Groningen

Date Written: November 2018

Abstract

Most regulators grant contingent convertible bonds (CoCos) the status of equity. The 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: Bank Capital Structure, Basel III, CoCos, Contingent Convertible Bonds, Debt overhang

JEL Classification: G01

Suggested Citation

Goncharenko, Roman and Ongena, Steven R. G. and Rauf, Asad, The Agency of Cocos: Why Contingent Convertible Bonds Aren't for Everyone (November 2018). CEPR Discussion Paper No. DP13344, Available at SSRN: https://ssrn.com/abstract=3295002

Roman Goncharenko (Contact Author)

KU Leuven ( email )

Oude Markt 13
Leuven, Vlaams-Brabant 3000
Belgium

Steven R. G. Ongena

University of Zurich - Department 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

NTNU Business School ( email )

Norway

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Asad Rauf

University of Groningen ( email )

Nettelbosje 2
Duisenburg Building, 8th Floor
Groningen, Groningen 9747AE
Netherlands

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