Rethinking Capital Structure


"The results of Duke University survey were reassuring in some respects and surprising in others.  With respect to capital budgeting, most companies follow academic theory and use discounted cashflow (DCF) and net present value (NPV) techniques to evaluate new projects.  But when it comes to making capital structure decisions, corporations appear to pay less attention to finance theory and rely instead on practical, informal rules of thumb.”

Interconnections between Commercial and Financial Risk

Corporate treasurers may have been spoilt in the immediate aftermath of the global financial crisis- as quantitative easing (QE) gives way to quantitative tightening (QT), treasury management is becoming increasingly challenging.  This is further complicated by unprecedented geopolitical uncertainty (Brexit, trade wars) and heightened volatility across asset classes (foreign exchange, equity and fixed income) and regions (developed as well as emerging markets). Michael Anthony, Managing Director of Global Thought Leadership, Corporate Risk Solutions at HSBC, adds that another notable by-product of elevated turmoil is that financial risk fuelled by currency and interest rate volatility is becoming inescapably interwoven with commercial risk. In other words, the competitiveness of longstanding business models may be at risk of erosion from cost pressures driven by adverse geopolitical trends. As Anthony says, today’s is a fast-moving global environment in which few CFOs have the luxury of waiting several years to assess how their business models may be affected by Brexit, for example, or trade frictions between the US and China. It is essential that corporates adopt an integrated approach to risk management. This recognises the interconnectedness between key elements ranging from funding decisions to M&A, industrial production strategies and so-called financial plumbing, such as cash-pooling.

In a recent HSBC Risk Management Survey2:

  • 70 per cent of CFOs report that their company has been hit by unhedged FX exposures in the past two years that could have been avoided. 

  • 87% say that their treasury plays a key role in strategic decision-making;

  • 38% indicate that risk management is the area in which they are most in need of developing further expertise. 


Because the world keeps
changing, treasurers have
to keep on measuring
and adapting.


Solid Foundations based on detailed Analytics

HSBC’s Thought Leadership practice is well-positioned to respond to this requirement, using its analytical expertise to help its corporate clients build the solid foundations required to safeguard against geopolitical and financial risk. Anthony explains that this process begins with risk discovery and risk quantification, aimed at giving CFOs and treasurers enhanced visibility on the efficiency of their capital structure and ensuring that their key performance indicators (KPIs) are consistent with their short and long-term goals. As an example, Anthony points to the importance of analysing a company’s capital structure from a holistic perspective. “We measure the efficiency of a company’s capital structure as a whole by looking at volatility of earnings and debt from a currency and financing perspective, in order to identify where risk is being created and where it is being mitigated,” he says. This is not a simple one-to-one matching exercise. Analysis of volatility, correlation and accounting all has to be taken into account.


The Value of Benchmarking

Fundamental to risk discovery and quantification for corporates, says Anthony, is a process of benchmarking. This is a valuable way of helping CFOs to measure the efficiency of their treasury operations relative to their peers and competitors. Typically, this is based on an analysis of key variables such as volatility of cash flow, earnings and debt costs relative to those of companies in the same sector and with comparable credit ratings.


Filling a Need

Treasurers will need to adopt an increasingly dynamic approach to risk management in order to ensure that their capital structure has the robustness and flexibility it needs to respond to ever-changing external influences. Because the world keeps changing, treasurers have to keep on measuring and adapting; there is no longer any room for a ‘set it and forget it’ mentality.  Like many other teams, treasury is being asked to do more with less. Using the analysis that HSBC’s Thought Leadership provides fills a need that has not been resourced with the thinning of treasury teams. HSBC’s Thought Leadership analytical output is often used as an objective way for CFOs and treasurers to validate or refine their risk management strategies and – if necessary – to align them with those of their competitors. We’re not a group that delivers execution strategies,” Anthony explains. “We identify risk parameters and provide guidance on risk quantification, but we don’t tell clients what products they should use. We are confident, however, that if we demonstrate a consistent track record of giving candid, unbiased and valuable analytics to clients, it will help strengthen their relationship with HSBC.”


1. Source: Journal of Applied Corporate Finance(“The Theory and Practice of Corporate Finance: Evidence from the Field” by John Graham and Campbell Harvey, Duke University), originally published in the Journal of Financial Economics, Vol. 60 (2001), which won the Jensen prize for the best JFE paper in corporate finance in 2001.

2. 200 CFOs and 300 treasurers were interviewed globally.