Does contingent capital induce excessive risk-taking?

Berg, Tobias; Kaserer, Christoph

doi:10.1016/j.jfi.2014.11.002

Cited by 96 publications

(84 citation statements)

References 52 publications

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“…But the risk shifting incentives induced by CoCos may result in upward pressure on probability of default (Koziol and Lawrenz (2012), Hilscher and Raviv (2014), Berg and Kaserer (2015), Chan and van Wijnbergen (2017), Goncharenko (2017)). …”

Section: Introductionmentioning

confidence: 99%

The Agency of CoCo: Why Do Banks Issue Contingent Convertible Bonds?

2017

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Why do banks issue contingent convertible debt? To answer this question we study comprehensive data covering all issues by publicly traded banks in Europe of contingent convertible bonds (CoCos) that count as additional tier 1 capital (AT1). We find that banks with lower asset volatility are more likely to issue AT1 CoCos than their riskier counterparts, but that CDS spreads do not react following issue announcements. Our estimates therefore suggest that agency costs play a crucial role in banks' ability to successfully issue CoCos. The agency costs may be higher for CoCos than for equity explaining why we observe riskier or lowly capitalized banks to issue equity rather than CoCos.JEL-Classification: G01, G12, G24

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Section: Introductionmentioning

confidence: 99%

The Agency of CoCo: Why Do Banks Issue Contingent Convertible Bonds?

2017

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Section: Principal Write Down (Pwd) Cocos and Risk Shifting Incentivesmentioning

confidence: 99%

“…Among the papers that mention these are Berg and Kaserer (2014) and Martynova and Perotti (2015). Berg and Kaserer (2014) considers 100% writedown CoCos, termed as "convert to steal" and show using numerical methods that this type of CoCo increases banks' incentives to increase risk. On the other hand, Martynova and Perotti (2015) opine that full writedown CoCos reduce risk shifting incentives, as the fall in debt due to conversion effectively raises the bank's skin in the game.…”

Section: Principal Write Down (Pwd) Cocos and Risk Shifting Incentivesmentioning

confidence: 99%

Coco Design, Risk Shifting and Financial Fragility

Chan

Wijnbergen

2016

SSRN Journal

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in EconStor may AbstractWe highlight the ex ante risk-shifting incentives faced by a bank's shareholders/managers when CoCos (contingent convertible capital) are part of the capital structure. The risk shifting incentive arises from the wealth transfers that the shareholders will receive upon the CoCo's conversion under CoCo designs widely used in practice. Specifically we show that for principal writedown and nondilutive equity-converting CoCos, shareholders/managers have an incentive to take on more risk to make conversion more likely because of those wealth transfers. As a consequence, wide spread use of CoCos will increase systemic fragility. We show that such improperly designed CoCos should not be allowed to fill in loss absorption capacity requirements unless accompanied by higher required equity ratios to mitigate the increased risk taking incentives they lead to. Sufficiently dilutive CoCos do not lead to undesired risk taking behavior.JEL classification: G01, G13, G21, G28, G32 Nontechnical SummaryCoCos are instruments that start out as debt and then either convert to equity or are written off upon the occurrence of a trigger event. This makes them very attractive to regulators as they avoid a costly bailout by providing loss absorption capacity. However, the design of CoCos may cause bank shareholders to choose actions now that necessitates the loss absorption capacity in the future. Prior to conversion, there is no discernible difference between CoCos and ordinary subordinated debt. However, after conversion, the payoffs to CoCo holders and shareholders are altered drastically, leading to potential wealth transfers from CoCo holders and shareholders. If the shareholders are better off after conversion, then they will choose actions that make conversion more likely. However, these actions have to be decided upon and implemented before anything else occurs. Therefore we examine the expected value of residual equity and determine which action maximizes it.In our setup, the action is a decision about the riskiness of the assets that the bank invests in. Our base case uses subordinated debt in the capital structure, and our analysis involves replacing the subordinated debt with the same amount of CoCos. The expected value of residual equity with CoCos can be expressed as the value of residual equity with subordinated debt, plus an expected wealth transfer. With this formulation, we can very easily say whether the CoCo indu...

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“…(1)) behaves like a call option on the firm's assets and under the given assumptions, the value of equity can be calculated as a combination of a standard call and a binary option, representing the 10 Some of the further modification are motivated by a former version of Berg and Kaserer (2014) (August 2012). 11 Berg and Kaserer (2014) call this type of CCB ''Convert-toSteal''. influence of the CCB.…”

Section: Modelmentioning

confidence: 99%

“…If shareholders are better situated after conversion, CCB provide an additional capital buffer and hence an extra appeal for risk. On the contrary, if CCB holders are equally or even better situated after conversion, the risk preference of the shareholders shifts to a more prudent one (Maes and Schoutens, 2012;Berg and Kaserer, 2014). Besides the conversion rate, the trigger position can influence the risk-taking incentive as well (Koziol and Lawrenz, 2012).…”

Section: Introductionmentioning

confidence: 99%

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

Walther

Klein

2015

Cuadernos de Economía

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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,

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Does contingent capital induce excessive risk-taking?

Cited by 96 publications

References 52 publications

The Agency of CoCo: Why Do Banks Issue Contingent Convertible Bonds?

The Agency of CoCo: Why Do Banks Issue Contingent Convertible Bonds?

Coco Design, Risk Shifting and Financial Fragility

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

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