Contingent capital: a theoretical and empirical analysis

This thesis is about the design of contingent capital (CoCos) to induce monitoring and to therefore reduce the expected size of taxpayer funded bailouts. CoCos are debt instruments that either convert into debt or are written down when a bank approaches distress—based on a reduction in the bank's capital. The thesis begins with a moral hazard model that provides a stylised illustration of the circumstances where either shareholders or CoCo investors can be induced to monitor. It predicts that shareholders will monitor if conversion reduces their claim to zero and CoCo investors will monitor if conversion reduces the value of their claim below what they paid when the CoCo was issued. It then assess different elements of the model—including the social cost that gives rise to the need for bailouts, the usual mechanisms to reduce the need for bailouts, and the bank specific insolvency regime adopted in the European Union. The focus then turns to monitoring incentives induced by CoCos. It discusses triggers and advocates higher minimum trigger levels. It then defines monitoring in the context of CoCos, assesses the extent to which monitoring is undertaken in CoCo markets, and makes recommendations about how incentives to monitor might be strengthened.