OPTIMAL CAPITAL STRUCTURE REPRISE
The elusive optimal capital structure puzzle has grown into an exercise in asset-liability management. Cash, investments, corporate pensions, litigation, and other reserves complicate the picture. The size and variability of corporate pensions show that optimal capital structure solutions must go beyond leverage ratios to prescribe optimal liquidity, pension investment and funding, and strategies for other assets and liabilities from a holistic, ALM perspective.
Though we do measure financial leverage, floating rate exposure, weighted average coupon, and duration, these metrics are static values bearing limited insight and providing unclear direction for managers. And despite the proliferation of efficient frontier and Value at Risk (VaR) analytics, these analysis are often confusing and lack prescriptive guidance for executives. Many managers have been left wondering: Where should we be on this efficient frontier? and How much VaR is the right amount? We too employ these analytics but draw upon clear goals and constraints with actionable guidance for value maximization.
Our framework for optimal capital structure employs an ALM perspective to determine guidance and direct implementation, with a focus on intrinsic value maximization within the constraints of appropriate levels of risk for the business.
Intrinsic value is typically at the perspective of consolidated cash flows (or core earnings as proxy) and net economic exposures ...