Corrigendum to “Corporate Bond Clawbacks as Contingent Capital for Bank."

Posted: 29 May 2020

See all articles by Kenneth N. Daniels

Kenneth N. Daniels

Daniels Foundation for Impact Investments and Development

Date Written: 2019

Abstract

We propose a contingent claw-back bond (COCLA) as an alternative source of contingent convertible capital (CoCo). We develop a utility maximization model in which a bank manager faces the following two trade-offs: one trade-off is between the private benefits of control and costs of financial distress when loans under-perform, and the other is between the costs and benefits of screening loan credit quality (effort). In our model, the supply of loans, amount of junior debt issued, level of effort exerted by a manager, and manager's decision to exercise the claw-back option are endogenously determined in the maximization of the manager's utility function. We find that the manager optimally exercises the claw-back following a low realization of cash flows, thereby solving the trigger problem presented in CoCos. In the model, the debt to equity conversion from the COCLA is an endogenous decision, the regulatory capital adequacy ratio (CAR) is satisfied, and the bank does not face distress costs. From a practical perspective, the conversion rate for the COCLA that jointly maximizes the manager's expected utility and stock holders’ pay offs is around 25%, a rate close to the typical percentage (30%–35%) that is often found in initial public offering clawback (IPOC) contracts used in the corporate world.

Keywords: Contingent Capital, Capital Asset Ratio

Suggested Citation

Daniels, Kenneth N., Corrigendum to “Corporate Bond Clawbacks as Contingent Capital for Bank." (2019). Journal of Financial Stability, Volume 41 Pages 105, March 2019, Available at SSRN: https://ssrn.com/abstract=3583313

Kenneth N. Daniels (Contact Author)

Daniels Foundation for Impact Investments and Development ( email )

New Jersey, NJ 07018
United States

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