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Contingent Capital, Real Options, and Agency Costs
Author(s) -
Song Dandan,
Yang Zhaojun
Publication year - 2016
Publication title -
international review of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 0.489
H-Index - 18
eISSN - 1468-2443
pISSN - 1369-412X
DOI - 10.1111/irfi.12076
Subject(s) - convertible bond , agency cost , cost of capital , leverage (statistics) , economics , capital structure , incentive , monetary economics , microeconomics , debt , equity (law) , principal–agent problem , bond , business , finance , corporate governance , machine learning , computer science , political science , law , shareholder
This paper aims to clarify how contingent convertible bond (CoCo) as a debt financing instrument affects a firm's investment policy, agency cost of debt, and capital structure. We consider endogenous and exogenous conversion thresholds, respectively. Under the exogenous case, there is an explicit optimal fraction of equity allocated to CoCo holders upon conversion, such that the agency cost reaches zero. Numerical analysis demonstrates that under an endogenous conversion threshold, CoCo induces overinvestment, a higher leverage, a possible bigger agency cost, and a stronger incentive to increase risk. But if the conversion threshold is exogenously determined, almost the opposite holds true.