CoCos: A Promising Idea Poorly Executed

Hybrid securities — securities that combine the attributes of equity and bonds — have been a regular feature of capital markets ever since their introduction in the mid-19th century to help finance railway expansion in the United States. The use of hybrid securities in capital regulation of banks, however, is comparatively new. Flannery (2005) proposed the introduction of CoCos (Contingent Convertibles) to enhance market discipline on banks. Subsequently, several other researchers have proposed a wide variety of CoCo designs and debated the weaknesses in alternative structures. The numerous proposals differ with respect to at least four key features: (1) the amount of CoCos the bank should be required to issue; (2) the trigger for conversions; (3) the amount converted when the trigger is crossed; and (4) the price at which CoCos are converted into equity…