An Integrated Approach to Asset-Liability Management: Capital Structure Choices, Pension Fund Allocation Decisions and the Rational Pricing of Liability Streams

New EDHEC-Risk Institute Research Questions Current Corporate Pension Fund ALM Practices and Proposes a New Integrated Model for Analysing the Capital Structure of Corporate Sponsors and Pension Fund Allocation Decisions.

Author(s):

Lionel Martellini

Professor of finance at EDHEC Business School and scientific director of EDHEC-Risk Institute.

Vincent Milhau

Senior Research Engineer at EDHEC-Risk Institute.

 BNP Paribas Investment Partners Asset-Liability Management and Institutional Investment Management Research ChairNo comprehensive model is currently available for the joint quantitative analysis of capital structure choices, pension fund allocation decisions and their impact on rational pricing of liability streams. This conceptual problem is reinforced by new accounting reforms, which make it a real challenge to correctly assess the value of a pension plan in deficit with a weak sponsor company. EDHEC-Risk Institute has attempted to fill this gap by analysing the valuation of pension liabilities in the context of an integrated model of capital structure. The model is a stylised representation of the relationships between the stakeholders of a company with a pension plan, including shareholders of the sponsor company, bondholders, and beneficiaries of the pension fund (workers and pensioners). The new publication, An Integrated Approach to Asset-Liability Management: Capital Structure Choices, Pension Fund Allocation Decisions and the Rational Pricing of Liability Streams, contains the results of the second-year research work conducted at EDHEC-Risk Institute within the BNP Paribas Investment Partners research chair on asset-liability management and institutional investment management. The results show that leverage decisions have a strong impact on the fair value of pension liabilities, and conversely that the presence of a pension plan decreases the optimal leverage ratio. Besides, a fair assessment of a firm's creditworthiness can be done only when analysts and rating agencies have an integrated view of the firm's financial situation, a view that also takes into account the pension fund's situation and its funding status as well as its allocation strategy. The study also finds that interior optimal values may exist for allocation decisions. In an extension to a dynamic setting the study finds that risk-controlled strategies allow the pension fund to take more risks, which has a positive effect on equity value, while protecting pensioners.The model has important policy implications for regulators, in that it provides a first step towards a much needed methodological framework for the design of firm-specific regulatory constraints and accounting valuation principles, and strategy implications for pension fund managers.

Type: EDHEC Publication
Date: le 10/12/2010
Research Cluster : Finance

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