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Working Paper
Optimal Design of Contingent Capital
This paper proposes a parsimonious framework for designing contingent capital contracts (CoCos). CoCos designed this way (i) are either optimal or incentive compatible for equity holders, (ii) implement a unique equilibrium, and (iii) result in an optimal capital structure for the firm. We consider CoCos with equity conversion and write-down modalities. Equity conversion CoCos are optimal; write-down CoCos are incentive-compatible. Both types of CoCos can be implemented by exogenously specifying a capital ratio rule that triggers conversion and, hence, qualify as additional tier 1 (AT1) ...