Strategic Corporate Finance: Applications in Valuation and Capital Structure

THE CASE FOR MORE BONDS

Just as many arguments against equity exist, many corollary reasons argue for increased fixed-income allocations in corporate pension assets, such as reduced risk, improved liability matching, transparency, cost, and tax efficiency.

Volatility

Although pension fund assets and liabilities are legally separate and uncon-solidated, pension assets affect the company because pension (defined) benefits are independent of fund performance. Portfolio gains and losses impact funding costs and the financial position of the company. Thus, pension fund performance affects credit quality, cash flows, earnings, and stock price.16 Though most risk is borne by the investors, pension members benefit from reduced risk; member legal protection is weaker in many jurisdictions where there is no equivalent to the PBGC.

Increased fixed-income allocation can reduce earnings volatility from corporate pensions and improve earnings quality and liquidity for strategic investments in growth. Reducing volatility in pension asset returns increases the capacity for risk bearing of the sponsoring company leading to more debt capacity, higher quality debt, lower WACC, and higher multiples.

Natural Hedge

Fixed-income returns can be better matched to meet projected benefit obligations and insulate company shareholders from corporate pensions. Equity returns are neither stationary nor predictable and, therefore, cannot be matched to meet pension obligations. In the absence of credit risk, the ...