Strategic Corporate Finance: Applications in Valuation and Capital Structure

CASE STUDY: TREATMENT OF PENSION AND POSTRETIREMENT LIABILITIES

In their analysis of profitability, the agencies have long attempted to normalize or undo certain distortions or problematic accounting treatments, attempting to strike a balance between what is most economically reflective and what is practical.

In early 2003, the agencies clarified their incorporation of the economic obligation of underfunded defined benefit pension and postretirement benefits.5 Where material, the agencies adjust capitalization and cash flow protection measures to reflect such obligations. In practice, the adjustments are neither universally nor mechanically applied and are most frequently made in the United States and for pensions (versus postretirement healthcare). Ratios are often calculated with and without the adjustments.

More recently, the Financial Accounting Standards Board (FASB) has been stirred to initiate a comprehensive review of pension and postretirement liability accounting. The first phase will involve shifting these liabilities from the footnotes to the balance sheet. The second phase, though further away from implementation, may involve greater recognition of other factors, such as variation in asset strategies and their inherent risks. Ratings agency treatments remain largely unaffected by this latter issue, with no formal recognition of the role that different asset strategies may play in credit quality.

In Figure 6.2, debt is increased by the after-tax total unfunded projected ...