Contingent capital with contingent share repurchase clause☆

Existing contingent convertible bonds (CoCos) have several drawbacks for investors and issuers. This paper introduces the CCCR, a hybrid security that improves upon CoCos by adding an automatic share repurchase mechanism, requiring the company to repurchase shares if its financial condition worsens after the conversion of contingent debt securities into equity. We develop a structural model based on Leland's framework to analyze a firm's optimal capital structure, which includes equity, CCCR, and a straight debt. The model endogenously determines the CCCR's features, and we derive pricing formulas for the firm's liabilities. To ensure applicability, we derive a condition and corresponding minimum conversion ratio ensuring a one-to-one mapping between equity value and firm asset value. Our analysis of credit spreads, asset substitution, and other key financial metrics shows that, compared to alternative financing options, capital structures incorporating CCCR offer significant advantages for investors while imposing minimal additional costs on issuing firms, establishing this new security as a rational and viable form of contingent capital.