Reactions to the EDHEC Study - Faculty and Research

Reactions to the EDHEC Study “Optimal Design of Corporate Market Debt Programmes in the Presence of Interest-Rate and Inflation Risks” - May 20122. Background and Methodologysimply a tool to pursue active views onfuture inflation or interest rates. If a firmfocuses on liabilities in isolation, issuingdebt which increases variability of debtcosts is naturally contrary to the goalof minimising and stabilising liabilities.The overall goal of a corporate issuer,however, is to maximise total firm value,while evaluating liabilities within its ownconfined framework ignores the impactof factors affecting the entire firm.Particularly for firms with revenue highlysensitive to interest rates or inflation (e.g.as depicted in Table 1), evaluating debtwith the goal of simple cost reductioncan have substantial effects on total firmvalue, as these tractable risk factors impactcash flows from assets and liabilities. Thus,a clear distinction can be made betweena pure liability strategy which segregatesliabilities from firm-wide risk factors, andone which integrates assets and liabilitiesinto a single coordinated framework.Parallel to a corporate issuer’s integratedasset-liability management strategy isan investor’s framework which evaluatesasset allocation within the context ofits liabilities. With regard to both issuersand investors, employing a strategyconstrained strictly to either assets orliabilities limits the ability to hedge firmwiderisks.The adoption of inflation-linked bonds aseither an investment or a form of issueddebt has distinct effects on investors andissuers, as described in the following table.The EDHEC-Risk study produces a strongtheoretical argument that issuanceof inflation-linked bonds could be ofmutual benefit to both corporations andinvestors. Current practices, however,are in disaccord with this finding, withrelatively few firms issuing inflationlinkedbonds. Thus, it was important toisolate the perspective of key stakeholderson our conclusions and to identify anypractical barriers to the development ofthe corporate bond market.Our analysis of the professional perspectivewas meant to be comprehensive andprecise; accordingly, two separatequestionnaires were issued to corporatefinance departments and institutionalinvestors, with questions tailored to theirunique concerns.Table 2IssuerInvestorPure Liability (or Asset) Focus-Useof fixed-rate debt- Fixed-rate debt allows for reduced risk from a puredebt-management perspective (i.e. it minimisesuncertainty/variability of debt-servicing cost).- If the investor’s focus is on nominal return, standardfixed debt has a certain cost (ignoring credit risk).Integrated Asset-Liability Focus-Useof inflation-linked debt- Reduces risk from an asset-liability managementperspective; reduces variability of firm-wide cashflows, net of debt payments, thus reducing chance ofdefault and as a result, maximising firm value- Allows for inflation risk matching of assets andliabilities- Perfect inflation hedge; possibility of directlymatching liabilities tied to same inflation index.- If liabilities are linked to inflation, then inflationlinkedcorporate bonds are a way to create a safeasset – liability-hedging portfolio (LHP).- In particular corporate bonds may be morereasonable than sovereign bonds when hedgingcorporate pension fund liabilities (Scherer 2006).10 An EDHEC-Risk Institute Publication