Dynamic capital structure and the contingent capital option

Barucci, Emilio; Viva, Luca Del

doi:10.1007/s10436-012-0188-z

Cited by 37 publications

(6 citation statements)

References 17 publications

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“…It is not difficult to derive from that not surprisingly, the optimal bankruptcy threshold

δ_{B}^{*}

increases with the coupon c as well as the coupon b .In addition, if

c = β = 0

in , i.e., CCS is not effectively included in the capital structure, or if we let

δ_{D} \to + \infty

, i.e., CCS is simplified into CoCo, we therefore recover from a standard conclusion in corporate finance theory. That is, the optimal bankruptcy threshold

δ_{B}^{*}

is given by:

δ_{B}^{*} = \frac{false(1 - θ false) false(r - μ false) γ_{+}}{r false(γ_{+} + 1 false)} b,

which is also derived by Barucci and Viva ().…”

Section: Pricing Of Corporate Securitiesmentioning

confidence: 93%

Contingent capital with repeated interconversion between debt‐ and equity‐like instruments

Cai

Yang

Zhao

2018

Euro Fin Management

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This paper introduces a new form of contingent capital, contingent convertible securities (CCSs), which might repeatedly convert between debt‐ and equity‐like instruments depending on financial conditions. We derive explicit prices of corporate securities, assuming the cash flow is modeled as a geometric Brownian motion. We present an explicit value of the increased tax shields due to CCSs. We provide an explicit optimal capital structure when CCSs are issued and interestingly, the ratio of the optimal straight bond coupon to CCS coupon is constant and independent of the firm's financial conditions. All the conclusions hold true also for contingent convertibles.

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“…It is not difficult to derive from that not surprisingly, the optimal bankruptcy threshold

δ_{B}^{*}

increases with the coupon c as well as the coupon b .In addition, if

c = β = 0

in , i.e., CCS is not effectively included in the capital structure, or if we let

δ_{D} \to + \infty

, i.e., CCS is simplified into CoCo, we therefore recover from a standard conclusion in corporate finance theory. That is, the optimal bankruptcy threshold

δ_{B}^{*}

is given by:

δ_{B}^{*} = \frac{false(1 - θ false) false(r - μ false) γ_{+}}{r false(γ_{+} + 1 false)} b,

which is also derived by Barucci and Viva ().…”

Section: Pricing Of Corporate Securitiesmentioning

confidence: 93%

Contingent capital with repeated interconversion between debt‐ and equity‐like instruments

Cai

Yang

Zhao

2018

Euro Fin Management

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“…We note that (1−β) represents the rate of loss that shareholders undergo if conversion occurs. According to Barucci and Del Viva (2013), the conversion rate is identified as follows β=minfalse(ccNrEcNfalse(xcNfalse),1false).…”

Section: Modeling Of Corporate Securitiesmentioning

confidence: 99%

Firms' financial structure with contingent convertible debt, risky debt and multiple growth options

Triki

Abid

2023

CFRI

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PurposeThe objective of this paper is twofold: first, to model the value of the firm in the presence of contingent capital and multiple growth options over its life cycle in a stochastic universe to ensure financial stability and recover losses in case of default and second, to clarify how contingent convertible (CoCo) bonds as financial instruments impact the leverage-ratio policies, inefficiencies generated by debt overhang and asset substitution for a firm that has multiple growth options. Additionally, what is its impact on investment timing, capital structure and asset volatility?Design/methodology/approachThe current paper elaborates the modeling of a dynamic problem with respect to the interaction between funding and investment policies during multiple sequential investment cycles simultaneously with dynamic funding. The authors model the value of the firm in the presence of contingent capital that provides flexibility in dealing with default risks as well as growth options in a stochastic universe. The authors examine the firm's closed-form solutions at each stage of its decision-making process before and after the exercise of the growth options (with and without conversion of CoCo) through applying the backward indication method and the risk-neutral pricing theory.FindingsThe numerical results show that inefficiencies related to debt overhang and asset substitution can go down with a higher conversion ratio and a larger number of growth options. Additionally, the authors’ analysis reveals that the firm systematically opts for conservative leverage to minimize the effect of debt overhang on decisions so as to exercise growth options in the future. However, the capital structure of the firm has a substantial effect on the leverage ratio and the asset substitution. In fact, the effect of the leverage ratio and the risk-shifting incentive will be greater when the capital structure changes during the firm's decision-making process. Contrarily to traditional corporate finance theory, the study displays that the value of the firm before the investment expansion decreases and then increases with asset volatility, instead of decreasing overall with asset volatility.Research limitations/implicationsThe study’s findings reveal that funding, default and conversion decisions have crucial implications on growth option exercise decisions and leverage ratio policy. The model also shows that the firm consistently chooses conservative leverage to reduce the effect of debt overhang on decisions to exercise growth options in the future. The risk-shifting incentive and the debt overhang inefficiency basically decrease with a higher conversion ratio and multiple growth options. However, the effect of the leverage ratio and the risk-shifting incentive will be greater when the capital structure changes during the firm's decision-making process.Originality/valueThe firm's composition between assets in place and growth options evolves endogenously with its investment opportunity and growth option financing, as well as its default decision. In contrast to the standard capital structure models of Leland (1994), the model reveals that both exogenous conversion decisions and endogenous default decisions have significant implications for firms' growth option exercise decisions and debt policies. The model induces some predictions about the dynamics of the firm's choice of leverage as well as the link between the dynamics of leverage and the firm's life cycle.

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“…Next, we consider the case assumed by Pennacchi () or Barucci and Del Viva (), where the ownership stake is defined by

β = normalm normali normaln ({},, \frac{c_{c} / r}{E_{a} (δ_{C})}, 1) .

…”

Section: The Equilibrium Pricing Of Corporate Securities and Optimal mentioning

confidence: 99%

“…Barucci and Del Viva () analyze the optimal capital structure of a bank issuing countercyclical CoCos, that is, notes to be converted in common shares in case of a bad state of the economy. Barucci and Del Viva () study the optimal capital structure of a firm issuing the perpetual CoCo, SB, and equity with a two‐period model. However, in contrast to the literature, the main purpose of this paper is to clarify how CoCo as a debt financing instrument affects the firm's investment policy, agency cost of debt, and optimal capital structure.…”

Section: Introductionmentioning

confidence: 99%

Contingent Capital, Real Options, and Agency Costs

Song

Yang²

2016

Int Rev Finance

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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.

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Dynamic capital structure and the contingent capital option

Cited by 37 publications

References 17 publications

Contingent capital with repeated interconversion between debt‐ and equity‐like instruments

Contingent capital with repeated interconversion between debt‐ and equity‐like instruments

Firms' financial structure with contingent convertible debt, risky debt and multiple growth options

Contingent Capital, Real Options, and Agency Costs

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