Strategic Corporate Finance: Applications in Valuation and Capital Structure

EXTEND DURATION WHEN RATES ARE LOW

Beyond managing down the overall proportion of debt within your capital structure, a low rate era brings further opportunity to create value in optimizing the construct of your debt portfolio—liability management. We use an efficient frontier approach that draws from portfolio theory with liability management application to evaluate the cost-risk trade-offs around your decisions for fixed-floating mix and term/duration structure.

Liability management has traditionally centered decisions on vague notions of asset-liability matching (ALM). Most companies establish a stable policy to somehow reflect the asset mix in their business by implicitly matching assets and liabilities. A common policy, for example, is to maintain a fixed-floating mix of 60:40 if fixed assets tend to be 1.5×net working capital.

But these simplistic practices of ALM do not provide a natural hedge. The relative amount of net working capital is roughly constant over time, suggesting it is really a permanent asset. Nor does the rate of return generated by working capital typically reflect the cost of floating-rate debt. However, true ALM approaches do prove useful (as we will discuss in Chapters 10, 11, and 12), and it is important to view floating-rate exposure more holistically, including the impact of cash and other investments, pension assets and liabilities, and so forth.

Another common approach is to try to balance financial risk against operating risk. Businesses with stable ...