According to the solution, given to be C, lowering equity holdings in the pension (plan) means higher fixed income, and this will increase the ratio (the Company’s debt/ equity ratio). However, this cannot be so. Lowering the pension plan’s equity allocation does not affect the right hand side of the Company’s balance sheet at all. The Company’s balance sheet and its debt/equity ratio do not change. The likely explanation for answer C should be instead that, with the lower equity allocation of the pension plan, the Company’s equity beta will decrease and this would enable management to voluntarily increase the Company’s debt/equity ratio in order to maintain its original equity beta. Any comments?
To keep its equity risk the same, D/E ratio will most likely increase.
so you mean while the pension plan changes its beta, the operating asset beta does not change, and the right side of the balance sheet has to change its beta?
Just found this question…I have the same concerns. This should not affect the D/E ratio. IF management decides they want to keep the same firmwide asset beta (incl pension) then they need to increase debt issuance and decrease equity outstanding (increasing the D/E ratio). Imo its a poorly worded question. I don’t even understand the solution.
