Executive summary:
From 1985 to 1990 Union Carbide Corporation experienced a transformation in its business model and financial statements, and as a result, major decisions were required in relation to some sensitive areas of the company, particularly the capital structure. The resulting proposal considered establishing a multi-target debt portfolio as a benchmark to manage the risk of leveraged capital structure. We explore some financial technical improvements that could be made to this approach to strengthen its scope, as well as discuss other organizational aspects that must be considered.
On December 3, 1984, a chemical accident in a Union Carbide Corporation’s (UCC) facility at India halted what at the time seemed to be a firm’s steady growth. Naturally, a plunge in its stock price followed and a takeover bid was launched by a chemical rival company in 1986. To fend off the takeover attempt, UCC issued $2.5 billion new debt and paid $0.8 billion in cash to repurchase 56% of its outstanding shares. Consequently, share of debt in its capital structure increased from 27% in 1985 to 46% at the end of 1986. Moreover, as a part of the restructuring process, UCC sold its two most profitable countercyclical retail businesses. As a result of these two actions, the firm confronted a downgrade rating on its senior debt (from BBB+ to BB-, having to pay higher interest rates on new debt) and also became more vulnerable to business cycle movements. Therefore, interest rate risk and liability management, due to the UCC’s high-leveraged capital structure, became a big concern and thus demanded higher levels of expertise.
In response to these concerns, the Treasurer’s Group (TG) proposed the design of a “benchmark debt portfolio” to measure the actual firm’s debt portfolio performance against the benchmark portfolio. It would: 1) assure the lowest financing cost to the UCC while minimizing simultaneously the interest rates risk, and 2) establish a...