Dynamic capital structure and the contingent capital option

Emilio Barucci, Luca Del Viva

Research output: Indexed journal article Articlepeer-review

22 Citations (Scopus)

Abstract

The financial crisis has emphasized the difficulties for financial companies to raise funds through conventional liabilities. In this environment, hybrid securities are becoming popular. In this paper we study the optimal capital structure of a company issuing a particular type of hybrid security: perpetual contingent capital, i.e., debt that converts into equity under some conditions. A two-period model with endogenous bankruptcy for a company with equity, straight debt and contingent capital is analyzed. We investigate the instrument under different conversion rules: automatic or optimally chosen by equity holders. We show that contingent capital reduces the coupon of straight debt and expected bankruptcy costs but can require a high spread. A trigger imposed by the regulatory authority in terms of par value of debt may induce a little use of contingent capital with an increase of bankruptcy costs.

Original languageEnglish
Pages (from-to)337-364
Number of pages28
JournalAnnals of Finance
Volume9
Issue number3
DOIs
Publication statusPublished - Aug 2013
Externally publishedYes

Keywords

  • Bankruptcy costs
  • Callable contingent capital
  • Convertible contingent capital
  • Dynamic capital structure
  • Leverage

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