Abstract
Including contingent convertible bonds (coco) in the capital structure of a bank affects the sensitivity to risk of its equity-based compensation. Such risk-shifting incentives can be reduced if the coco bonds are well-designed. Similarly, we show that compensating executives with well-designed coco bonds can also reduce risk-shifting incentives. In practice, however, most coco bonds have characteristics that result in both stock and coco compensation having large sensitivities to changes in asset risk - equity-based compensation encourages executives to increase risk, coco compensation to reduce risk. We show that a pay package combining both stock and coco can practically eliminate risk-shifting incentives and that it can be implemented with a bank's preexisting coco bonds.
Original language | English |
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Article number | 2240005 |
Journal | Quarterly Journal of Finance |
Volume | 12 |
Issue number | 1 |
DOIs | |
State | Published - 1 Mar 2022 |
Bibliographical note
Publisher Copyright:© 2022 World Scientific Publishing Company.
Keywords
- Banking regulation
- Coco compensation
- Contingent capital
- Executive compensation
- Risk-shifting