Research Seminar: Kebin Ma - Warwick

Abstract

We empirically document and theoretically investigate why non-dilutive CoCos are prevalent, even though advocates of CoCos suggest such securities should be dilutive to reduce bank risk-taking. In an agency model with two subsequent moral hazards, we show that while dilutive CoCos deter ex-ante risk-taking and prevent a bank from being undercapitalized, penalizing existing shareholders with dilution when the bank is already undercapitalized leads to risk shifting. CoCos’ designs and risk implications depend on banks’ equity capitalization, with nondilutive CoCos particularly attractive to capital-constrained banks, because such securities can maximize the banks’ financing capacity by tackling only the ex-post risk shifting.

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