Fixed Prices and Regulatory Discretion as Triggers for Contingent Capital Conversion: An Experimental Examination
by Douglas Davisa and Edward Simpson Prescottb
We report a laboratory experiment that evaluates two
price-based mechanisms for triggering the conversion of
contingent-capital bonds into equity: a regulator who decides
based on observed prices and a mechanistic fixed-price trigger.
We find that when conversion decreases incumbent equity
value, the regulator mechanism generates fewer conversion
errors, particularly in environments where incentives bias a
regulator against conversion and where a regulator receives his
own signal. In contrast, when conversion increases incumbent
equity value, a fixed-price trigger generates fewer conversion
errors in these environments as well as when the regulator has
the option to delay conversion.
JEL Codes: C92, G14, G28.
Full article (PDF, 39 pages, 519 kb)
Online Appendix (PDF, 52 pages, 715 kb)
a Virginia Commonwealth University
b Federal Reserve Bank of Cleveland