Strategic Corporate Finance: Applications in Valuation and Capital Structure

TRENDS AND IMPLICATIONS

Many factors have contributed to the current condition. High volatility and a difficult operating environment created the need for excess liquidity. Ratings agencies and analysts have been vocal advocates of excess liquidity after having been burned by many high-profile corporate liquidity crunches. And historically low interest rates reduced the opportunity cost of being overcapitalized. But the tides have shifted and new economic forces have created the impetus for change.

Balance Sheets Mended

Leverage and credit quality are on the mend. A reduction in financial leverage creates less need for balance sheet liquidity. Total adjusted leverage for all NYSE and NASDAQ listed companies declined from 51 percent debt/capital in 2002 to 39 percent in 2004. Global speculative grade defaults fell from 8 percent to 1 percent.

And while American issuers are evaluated on a gross debt basis, European and Asian issuers are frequently evaluated on a net debt basis, which would give an even more striking view. On a net debt basis, NYSE and NASDAQ net leverage was down from 33 percent to 13 percent debt/capital over the same 2002 to 2004 period.

The spike in financial leverage at the start of the decade was exacerbated by additional obligations of unfunded postretirement health benefits and underfunded pension plans. Many ratings agency analysts more formally adopted methodologies that explicitly adjusted financial ratios for these obligations.

Pension underfunding, a ...