GLOBAL - Pension liabilities account for more than 30% of the market capitalisation of a typical Germany company and about 20% for typical UK and Japanese companies, according to new research by Watson Wyatt.
Watson Wyatt’s Global Investment Review found that pension liabilities in a typical Swiss or US company represent about 15% of market capitalisation, while in Canada, the figure is around 10%.
Roger Urwin (pictured), global head of investment consulting at Watson Wyatt, said: “The burden of debt is weighing increasingly heavily on corporate finances, affecting credit ratings and analysts forecasts and making takeovers, re-financing and capital-raising more problematic.”
According to the research, treating pension liabilities as debt-like obligations reveals company’s “true risk positions” by showing how an increase in debt financing can both reduce the certainty of the return on that company’s investment and increase the chance of default if those investments turn out to be unsound.
“Higher leverage pushes down credit ratings and pushes up the cost of debt financing,” Urwin said. “It is also likely to lead to more volatility in a company’s stock price, which is how the market deals with uncertain returns on operating investments. This is a big challenge for corporations with large pension deficits.”
Watson Wyatt concluded that the larger the pension liabilities (for a given funding level) relative to the market capitalisation and the riskier the asset allocation in the pension fund, the more likely it is that the company leverage will be raised.
In addition, the research found median companies rated BBB or below had a higher pension risk exposure than the median company with a single A or better rating, although there was less discrimination between companies at the upper end of the scale. A correlation between a high debt burden, compared with the size of the company, and a more volatile stock price, was also noted.
“To many this may not seem like news, but we expect this will set alarm bells ringing in many corporate finance departments once this is fully appreciated,” Urwin said.
“However the size of a company’s pension exposure does not yet seem to be driving any major shift in asset allocation – companies with the biggest pension liabilities still have the same high exposure to equities. Therefore, it looks as if most companies are either hoping the markets will bail them out in the long term or they have not yet recognised the full implications of their pension liabilities on corporate indebtedness.”
The research covered 1600 mid and large-cap companies, all of which have defined benefit pension liabilities and report under comparable accounting standards.
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