Strategic Corporate Finance: Applications in Valuation and Capital Structure

WHY NOW?

The equity market recovery and higher interest rates create a healthier corporate pension funding position; higher asset values and lower actuarial projected benefit obligations put adequate funding within reach for most companies for the first time this decade. This environment creates a window of opportunity to isolate shareholders from corporate pensions and create intrinsic value through large and immediate increases in the fixed-income allocation of pension assets.

A perfect storm of low equity returns and interest rates created today’s underfunded position. The volatility of the net pension funding position and the severity of recent underfunding are problematic for capital planning.

As pledges of future cash flows, the ratings and investor analyst community increasingly view the net unfunded position as debt.1 The optimal prefunding level of a pension is a function of the company’s tax and legal jurisdiction, as well as ratings considerations.

Standard & Poor’s (S&P) reported that by 2002, the aggregate underfunding position of the S&P 500 companies alone (with defined benefit plans) was $219 billion but is expected to have improved to a $112 billion shortfall by 2004.

The U.S. Pension Benefit Guaranty Corporation (PBGC) insures the defined benefit pensions of 44 million Americans against employer bankruptcy and other plan failures. Nearly one million individuals receive (or are owed) benefits under plans that have been taken over by the PBGC. At the end of 2004, ...