Announcement Effects of Contingent Convertible Securities: Evidence from the Global Banking Industry

Date01 January 2017
Published date01 January 2017
DOIhttp://doi.org/10.1111/eufm.12092
Announcement Effects of Contingent
Convertible Securities: Evidence from
the Global Banking Industry
Manuel Ammann
University of St. Gallen, Swiss Institute of Banking and Finance, Rosenbergstrasse 52, 9000 St. Gallen,
Switzerland
E-mail: manuel.ammann@unisg.ch
Kristian Blickle
University of St. Gallen, Swiss Institute of Banking and Finance, Rosenbergstrasse 52, 9000 St. Gallen,
Switzerland
E-mail: kristian.blickle@unisg.ch
Christian Ehmann
University of St. Gallen, Swiss Institute of Banking and Finance, Rosenbergstrasse 52, 9000 St. Gallen,
Switzerland
E-mail: christian.ehmann@unisg.ch
Abstract
This paper investigates the announcement effects of CoCo bonds issued by global
banks between January 2009 and June 2014. Using a sample of 34 nancial
institutions, we examine abnormal stock price reactions and CDS spread changes
before and after the announcement dates. We nd that the announcement of CoCos
correlates with positive abnormal stock returns and negative CDS spread changes
in the immediate post-announcement period. We explain these effects with a set of
theories including the lowered probability of costly bankruptcy proceedings, a
signaling framework based on pecking order theory and the cost advantage of
CoCos over equity (tax shield).
Keywords: contingent convertible securities, CoCo bonds, announcement effects,
event study
JEL classification: G01, G14, G21
The authors would like to thank the participants of the University of St. Gallen research
seminar, the participants of the 10
th
Annual Business Research Conference at Imperial
College, London, Stephan H
ochst and Robert Van Kleeck from Assenagon Asset
Management, Stefan Weber from Swisscanto Asset Management and an anonymous
referee for their helpful comments. Correspondence: Christian Ehmann.
European Financial Management, Vol. 23, No. 1, 2017, 127152
doi: 10.1111/eufm.12092
© 2016 John Wiley & Sons, Ltd.
1. Introduction
During the 2007/08 nancial crisis, public-sector capital was frequently used as a fail-
safe to prevent the collapse of systemically relevant nancial institutions. Increased
government debt levels, disgruntled tax payers and a distortion of bankerseconomic
incentives were the ultimate consequences of such support mechanisms. Contingent
convertible debt securities, or CoCo bonds, have been regarded as an innovative remedy
to mitigate those problems. By automatically being written down or converting into
equity capital in the event of certain pre-dened triggers, these hybrid securities
ameliorate an entitys capital position at critical times. CoCo bonds have enjoyed interest
from both regulators and bank managers since their conceptual creation. In many
jurisdictions adopting Basel III, CoCo bonds can be used as core capital to meet
regulatory requirements. The advent of the CoCo bond and the concomitant discussions
of a bail-incould be seen as marking a shift in the way regulators plan to treat
destabilised nancial institutions in the future.
Accordingly, total global issue volumes of CoCo bonds have reached approxi-
mately 115 billion USD since January 2009. While the market for CoCos is still
relatively small, comp ared to the volumes of bank- issued (non-continge nt)
subordinated debt and se nior unsecured debt instr uments, it is steadily grow ing. In
2013, 26 global nancial institutions issued 34 CoCo bonds with a total face value of
around 40 billion USD. In the rst half of 2014 alone, issue volumes alrea dy reached
36.5 billion USD. In comp arison, according to inf ormation provided by D ealogic, the
total volume of equity issued by global nancial corporations amounted to
approximately 154 billion USD in 2014. In the period from January to May 2014,
European banks issued around 36 billion USD of new equity, as stated by the
Financial Times (2014). Hence, the importance of CoCo bond issues, compared to
initial or seasoned equity issues undertaken by nancial intermediaries, is clearly on
the rise. Appendix 1 shows the volumes of global contingent convertible bond issues
from 1 January 2009 until 30 June 2014. According to an industry report released by
Standard and Poors (2010), CoCo bond volumes are expected to reach 1 trillion USD
by the year 2020.
Whereas the announcemen t effects of conventional co nvertible securities on is suer
stock prices have been wide ly discussed, research on th e announcement effects of
contingent convertible bo nds issued by banks is sti ll absent. Our study llsthisgapin
the literature and investigates bo th the abnormal stock price and credit defa ult swap
spread reactions to the anno uncement of CoCos. We make use of a sample of 34
international banks and 8 7 distinct CoCo bond issues w ith a total nominal issue
volume of around 80 billion US D. As such, we capture a signi cant portion of this
new security market. Follo wing the standard methodol ogy of Brown and Warner
(1985) and Campbell et al. (199 7), we conduct an event study that investigates the
reactions of the CoCo bond issuersstock prices and CDS spreads in the immedi ate
post-announcement period.
Empirical research on conventional convertible debt securities suggests a negative
relationship between an announcement and the post-announcement abnormal stock
returns of the issuing entities. Duca et al. (2012) report signicant negative
announcement effects of convertible offerings for rms in the US between 1984 and
2008. Earlier studies, such as those by Billingsley and Smith (1996), Dann and
Mikkelson (1984), Lewis et al. (1999) and Mikkelson and Partch (1986) nd similar
© 2016 John Wiley & Sons, Ltd.
128 Manuel Ammann, Kristian Blickle and Christian Ehmann

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