Bond clawback provisions allow the issuer to partially redeem a bond issue often within 3years of issuance using proceeds only from new equity issues. We document that clawback bonds are often renegotiated and clawbacks provisions are rarely exercised. We find that the probability of exercising the clawback option increases if the firm has lower leverage, has better return on equity, and is not issuing in the 144 market. We also find that the higher yields observed on clawback bonds are associated with the likelihood of the clawback provision being exercised. We argue that the results are consistent with the view that firms that use clawback provisions are likely to have better fundamentals. These firms exercise the clawback provision because the firm is able to access the equity markets and issue the needed equity for exercising the clawback option. Renegotiation of clawback bond results from the need to refinance the high cost IPOC issues and the difficulty accessing the equity capital markets.

We propose a contingent clawback bond (COCLA) as an alternative source of contingent convertible capital (CoCo). We develop a utility maximization model in which a bank manager faces the following two trade-offs: one trade-off is between the private benefits of control and costs of financial distress when loans under-perform, and the other is between the costs and benefits of screening loan credit quality (effort). In our model, the supply of loans, amount of junior debt issued, level of effort exerted by a manager, and manager's decision to exercise the clawback option are endogenously determined in the maximization of the manager's utility function. We find that the manager optimally exercises the clawback following a low realization of cash flows, thereby solving the trigger problem presented in CoCos. In the model, the debt to equity conversion from the COCLA is an endogenous decision, the regulatory capital adequacy ratio (CAR) is satisfied, and the bank does not face distress costs. From a practical perspective, the conversion rate for the COCLA that jointly maximizes the manager's expected utility and stock holders’ pay offs is around 25%, a rate close to the typical percentage (30%–35%) that is often found in initial public offering clawback (IPOC) contracts used in the corporate world.