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Contingent Convertible Debt: The Impact on Equity Holders

Author

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  • Delphine Boursicot

    (Department of Decision Sciences, HEC Montréal and GERAD, 3000 chemin de la Cote-Sainte-Catherine, Montréal, QC H3T 2A7, Canada)

  • Geneviève Gauthier

    (Department of Decision Sciences, HEC Montréal and GERAD, 3000 chemin de la Cote-Sainte-Catherine, Montréal, QC H3T 2A7, Canada)

  • Farhad Pourkalbassi

    (Department of Decision Sciences, HEC Montréal and GERAD, 3000 chemin de la Cote-Sainte-Catherine, Montréal, QC H3T 2A7, Canada)

Abstract

Contingent Convertible (CoCo) is a hybrid debt issued by banks with a specific feature forcing its conversion to equity in the event of the bank’s financial distress. CoCo carries two major risks: the risk of default, which threatens any type of debt instrument, plus the exclusive risk of mandatory conversion. In this paper, we propose a model to value CoCo debt instruments as a function of the debt ratio. Although the CoCo is a more expensive instrument than traditional debt, its presence in the capital structure lowers the cost of ordinary debt and reduces the total cost of debt. For preliminary equity holders, the presence of CoCo in the bank’s capital structure increases the shareholder’s aggregate value.

Suggested Citation

  • Delphine Boursicot & Geneviève Gauthier & Farhad Pourkalbassi, 2019. "Contingent Convertible Debt: The Impact on Equity Holders," Risks, MDPI, vol. 7(2), pages 1-35, April.
    • Handle: RePEc:gam:jrisks:v:7:y:2019:i:2:p:47-:d:227019
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    References listed on IDEAS

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