Are contingent convertibles going-concern capital? |
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| Institution: | 1. Middlesex Business School and University of Rome III, Via S. D''Amico 77, 00145 Rome, Italy;2. Department of Finance, University of Illinois, 515 E. Gregory Drive, Champaign, IL, USA;3. University of Rome III, Via S. D''Amico 77, 00145 Rome, Italy;1. Columbia Business School, USA;1. Cass Business School, London, United Kingdom;2. CEPR, United Kingdom;3. Bank for International Settlements, Basel, Switzerland;1. Bank of Canada, 234 Wellington St, Ottawa, ON K1A 0G9, Canada;2. Centre for Economic Policy Research, London, United Kingdom;1. University of Rome Tor Vergata, Department of Economics and Finance, Via Columbia 2, Rome, Italy;2. University of Roma Tre, Department of Business Studies, via Silvio D’Amico 77, Rome, Italy;3. Middlesex University, Business School, The Burroughs Hendon, London NW4 4BT, United Kingdom;4. Bangor University, Bangor Business School, College Road, LL572DG Bangor, United Kingdom;1. University of Duisburg-Essen, Lotharstr. 65, 47057 Duisburg, Germany;2. Brazilian School of Public and Business Administration, Getulio Vargas Foundation, Rua Jornalista Orlando Dantas 30, 22231-010 Rio de Janeiro, Brazil;3. Braunschweig Institute of Technology, Abt-Jerusalem-Str. 7, 38106 Braunschweig, Germany |
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| Abstract: | Contingent convertibles (CoCos) are intended to either convert to new equity or be written down prior to failure while a bank is a going-concern. Yet, in the first actual test case, CoCos never converted before its bank failed. We develop a model that predicts that CoCos lead to less (more) extreme stock returns and have yields greater than (similar to) standard subordinated debt yields if investors do (do not) expect them to convert or be written down prior to failure. These predictions are tested using data on CoCos issued by European banks during 2011 to 2017. We find evidence that equity conversion CoCos reduce stock return variance and several other measures of downside risk, consistent with the perception that they are going-concern capital. However, we also provide event study evidence that recent regulatory actions reduced the CoCo–subordinated debt yield spread, which indicates a diminished investor belief that CoCos are going-concern capital. |
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