Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/130497 
Year of Publication: 
2016
Series/Report no.: 
Tinbergen Institute Discussion Paper No. 16-007/VI
Publisher: 
Tinbergen Institute, Amsterdam and Rotterdam
Abstract: 
We 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.
Subjects: 
Contingent Convertible Capital
Systemic Risk
Risk Shifting Incentives
Capital Requirements
JEL: 
G01
G13
G21
G28
G32
Document Type: 
Working Paper

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