Strategic Corporate Finance: Applications in Valuation and Capital Structure

CHAPTER 12

ERM Case Study: Reengineering The Corporate Pension

Increasingly, capital structure optimization involves issues beyond simple choices in ratings and leverage. Corporate finance’s elusive optimal capital structure puzzle has grown into an exercise in asset-liability management (ALM), with cash, investments, corporate pensions, and other (e.g., medical, environmental, litigation) assets and liabilities complicating the picture.

According to the Compustat database, corporate pension assets of New York Stock Exchange (NYSE) and National Association of Securities Dealers Automated Quotation (NASDAQ) listed firms reached $1.8 trillion (7 percent of economic value or EV) in 2005, up from just $900 billion in 1995. Moreover, cash and marketable securities have grown from $1.2 trillion to $12 trillion (12 percent to 44 percent of EV) over the same period. And though corporate pension underfunding is now largely on the mend, that the net position swung from a $250 billion surplus to a $500 billion deficit from 1999 to 2002 illustrates that optimal capital structure solutions are no longer just about how much debt or what kinds of debt.

Optimization must go beyond leverage ratios to prescribe optimal liquidity, pension funding and investment, and more from a holistic, ALM perspective. Despite their prevalence, prescriptive solutions do not readily emerge from efficient frontier analysis or from Value at Risk (VaR) analysis.

For example, the equity market recovery and rising interest ...