Contingent convertible bonds and their impact on risk-taking of managers

Abstract

This paper discusses how contingent convertible bonds (CCB) influence the risktaking behaviour of managers. A methodology to measure the impact is presented. The results show that the decision of issuing CCB to finance company assets sets incentives to managers to increase risk, if it is not adjusted to the compensation system. However, if the remuneration of managers is adjusted simultaneously with the issuance, e.g. with internal debt, the drawbacks of the sole compensation with stock options can be equalised. Furthermore, it was found that CCB does have an impact on the risk-taking behaviour, while CCB does not change the incentive to increase the company value at all. PALABRAS CLAVEbonos convertibles contingentes; remuneracíon de los directivos; incentivos; deuda interna; conductas de riesgo Bonos convertibles contingentes y su impacto en las conductas de riesgo de los directivosResumen Se analiza cómo los bonos convertibles contingentes (CCB) influyen las conductas deriesgo de los directivos. Se presenta una metodología para medir el impacto. Los resultados muestran que la decisión de emitir los CCB para financiar la empresa incentiva alos directivos a conductas más arriesgadas, si no se ajusta el sistema de compensación. Sin embargo, si la remuneracíon de los directivos se ajusta simultáneamente con laemisión, p.ej. con deuda interna, los inconvenientes de una única compensación con opciones se compensarían. Además,

Pricing contingent convertibles with idiosyncratic risk

“…Additionally, Barclays has sought approval from the UK regulators for paying its bankers (managing director level and above) with CoCo instruments (Hughes & Jenkins, 2011). The CoCo instruments in executive compensation are also argued by Walther and Klein (2015), Kagade and Verma (2015), and Kaal (2012) among others. However, the executives and managers have undiversified portfolios and naturally such CoCo holders would face significant idiosyncratic risk; see Jonathan and Ingersoll (2006).…”

The determinants of banks' AT1 CoCo spreads

“…Due to this regulation, the new hybrid asset class of additional tier 1 (AT1) contingent convertible (CoCo) bonds has emerged with 252 issuances between 2014 and November 2020, leading to a market valuation of €231 billion as measured by Barclays Global Contingent Capital Index. 1 The literature on CoCos has focused on the following aspects 2 : The advantages and the limitations of CoCos (Benink, 2018;Flannery, 2016), the optimal capital structure with CoCos (Attaoui & Poncet, 2015;Barucci & Del Viva, 2012), the security design and its effects (Allen & Tang, 2016;Cai et al, 2018;Chen et al, 2017;Davis & Prescott, 2017;Furstenberg, 2017), CoCo issuance motives (Araten & Turner, 2013;Bancel & Mittoo, 2004;Dutordoir et al, 2014;Fajardo & Mendes, 2020), its announcement effects on credit default swap (CDS) spreads (Ammann et al, 2017) and stock performances (de Spiegeleer et al, 2016;Liao et al, 2017), a banks' risktaking (Martynova & Perotti, 2018;Walther & Klein, 2015) and, specifically, the emergence and mitigation of moral hazard risks (Berg & Kaserer, 2015;Díaz et al, 2018;Hilscher & Raviv, 2014).…”

CEO inside debt and convertible bonds

“…Bolton, Mehran, and Shapiro () suggest that excess risk‐taking in the banking industry can be addressed by a compensation contract based on both stock price and credit default swap (CDS) spreads. Walther and Klein () suggest that the impact of contingent convertible bonds (CoCo bonds) on excessive risk‐taking can be neutralized once CoCo bonds are considered in the compensation contract.…”