Contingent capital, Tobin’s q and corporate capital structure

Abstract This paper examines the impact of contingent convertible (CoCo) financing on a firm’s Tobin’s q . We first construct an endogenous dynamic investment and capital accumulation model for pricing firm bonds under CoCo financing based on the neoclassical investment q theory and derive its semi-closed expression. Then, we numerically explore the mechanism by which CoCo financing affects the firm’s industrial investment strategy and Tobin’s q under the firm’s optimal capital structure. We prove the following: ( i ) After the conversion of CoCo, the measurement error between the Tobin’s average q and the Tobin’s marginal q decreases along with the increase in the firm’s capital stock, which echoes a variety of classical studies. ( i i ) However, before the conversion, a significant gap appears between Tobin’s marginal q and Tobin’s average q . And in this case the firm’s investment level is relatively low. ( i i i ) Compared with ordinary debt financing, the combined financing mode of CoCo and ordinary debt can effectively alleviate the debt overhang problem and eventually improve firms’ value.