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INCENTIVE EFFECTS FROM WRITE-DOWN COCO BONDS: AN EMPIRICAL ANALYSIS

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Jannic Cutura,
Jannic Cutura
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Henning Hesse
Henning Hesse
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Journal of Financial Regulation, Volume 8, Issue 2, September 2022, Pages
162–186, https://doi.org/10.1093/jfr/fjac005
Published:
15 August 2022
Article history
Received:
03 June 2021
Revision received:
18 November 2021
Accepted:
29 March 2022
Published:
15 August 2022

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Jannic Cutura, Henning Hesse, Incentive Effects from Write-down CoCo Bonds:
An Empirical Analysis, Journal of Financial Regulation, Volume 8, Issue 2,
September 2022, Pages 162–186, https://doi.org/10.1093/jfr/fjac005

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ABSTRACT

Departing from the principle of absolute priority, contingent convertible (CoCo)
bonds are particularly exposed to bank losses despite not having ownership
rights. In this article we show the link between adverse CoCo bond design and
their yields, confirming the existence of market discipline in designated
bail-in debt. Specifically, focusing on the write-down feature as a
loss-absorption mechanism in CoCo debt, we 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, we find this premium to
be largest when existing incentives for opportunistic behaviour are largest,
while the premium is non-existent if moral hazard is perceived to be small.
Overall, our findings support the notion of market discipline through monitoring
debt investors and have important implications for the optimal design of CoCos
from a regulatory perspective.

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