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Removing Moral Hazard and Agency Costs in Banks: Beyond CoCo Bonds

Author

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  • Kenjiro Hori

    (Department of Economics, Mathematics & Statistics, Birkbeck)

  • Jorge Martin Ceron

    (Department of Economics, Mathematics & Statistics, Birkbeck)

Abstract

The convex payoffs for equityholders in a corporate structure results in agency costs and moral hazard problems. The implicit government guarantee for banks accentuates these. We believe that the Basel III related bail-in contingent convertible (CoCo) structures do only not solve these problems, but may even aggravate them. In this paper we suggest solutions. The first is to replace the currently issued writedown/off and equity-conversion CoCo structures with a market-price equity-conversion CoCo bonds. This mirrors the full dilution effect of an ordinary equity raise in a distressed situation to reduce incentives for high risk-taking by equityholders. The second is to establish a Contingent Equity Base that replaces the incumbent shareholders once the CoCo is triggered. This will finally remove the perverse risk-taking incentives. The valuation of the CEB is then suggested.

Suggested Citation

  • Kenjiro Hori & Jorge Martin Ceron, 2016. "Removing Moral Hazard and Agency Costs in Banks: Beyond CoCo Bonds," Birkbeck Working Papers in Economics and Finance 1603, Birkbeck, Department of Economics, Mathematics & Statistics.
    • Handle: RePEc:bbk:bbkefp:1603
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    File URL: https://eprints.bbk.ac.uk/id/eprint/15261
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    References listed on IDEAS

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    Cited by:

    1. Philippe Oster, 2020. "Contingent Convertible bond literature review: making everything and nothing possible?," Journal of Banking Regulation, Palgrave Macmillan, vol. 21(4), pages 343-381, December.

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    More about this item

    Keywords

    CoCo bond; agency costs; moral hazard; bail-in; cost of equity.;
    All these keywords.

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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