Incentive effects from write-down CoCo bonds: an empirical analysis

  • Departing from the principle of absolute priority, CoCo bonds are particularly exposed to bank losses despite not having ownership rights. This paper shows the link between adverse CoCo design and their yields, confirming the existence of market monitoring in designated bail-in debt. Specifically, focusing on the write-down feature as loss absorption mechanism in CoCo debt, I do find a yield premium on this feature relative to equity-conversion CoCo bonds as predicted by theoretical models. Moreover, and consistent with theories on moral hazard, I find this premium to be largest when existing incentives for opportunistic behavior are largest, while this premium is non-existent if moral hazard is perceived to be small. The findings show that write-down CoCo bonds introduce a moral hazard problem in the banks. At the same time, they support the idea of CoCo investors acting as monitors, which is a prerequisite for a meaningful role of CoCo debt in banks' regulatory capital mix.

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Author:Henning Hesse
Parent Title (English):SAFE working paper series ; No. 212
Series (Serial Number):SAFE working paper series (212)
Place of publication:Frankfurt am Main
Document Type:Working Paper
Year of Completion:2018
Year of first Publication:2018
Publishing Institution:Universit├Ątsbibliothek Johann Christian Senckenberg
Release Date:2018/06/12
Tag:CoCo bonds; capital structure; contingent capital; endogenous risk; incentives; monitoring
Page Number:42
Institutes:Wirtschaftswissenschaften / Wirtschaftswissenschaften
Wissenschaftliche Zentren und koordinierte Programme / House of Finance (HoF)
Wissenschaftliche Zentren und koordinierte Programme / Center for Financial Studies (CFS)
Wissenschaftliche Zentren und koordinierte Programme / Sustainable Architecture for Finance in Europe (SAFE)
Dewey Decimal Classification:3 Sozialwissenschaften / 33 Wirtschaft / 330 Wirtschaft
Licence (German):License LogoDeutsches Urheberrecht