Contingent Capital: The Case of COERCs

George Pennacchi · Theo Vermaelen · Christian C. P. Wolff

117 citations0/0 files storedJournal of Financial and Quantitative Analysis

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Banking stability, regulation, efficiency Credit Risk and Financial Regulations finance, banking, and market dynamics

Abstract

Abstract This paper introduces and analyzes a new form of contingent convertible: a call option enhanced reverse convertible (COERC). If an issuing bank’s market value of capital breaches a trigger, COERCs convert to many new equity shares that would heavily dilute existing shareholders, except that shareholders have the option to purchase these shares at the bond’s par value. COERCs have low risk: They are almost always fully repaid in cash. Yet, they reduce government bailouts by replenishing a bank’s capital. COERCs’ design also avoids problems with market-value triggers, such as manipulation or panic, while reducing moral hazard and debt overhang.

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References

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