A Capital Structure Strategy Designed for Winning

# Capital Structure

Former HP treasurer and NeuGroup member Zac Nesper shares questions that unlock corporate treasury's full value to the enterprise. Today's focus: part one of his insights on capital structure strategy.

Zac Nesper

Editor's note: Zac Nesper's 20 years at HP included stints in FP&A and multiple treasury roles before he served as treasurer for five years. He led HP's treasury separation into two companies large enough for the Fortune 50, dealt with fallout from the pandemic, and helped defeat a hostile takeover attempt by Carl Icahn. His other articles on managing treasury through a strategic lens focus on FX risk management, working capital management and treasury talent. Decisions about capital structure are among the most consequential in corporate finance and arguably the most important decisions a treasurer ever makes. Yet many treasurers inherit capital structures rather than architect them. They also face whiplash. The textbook says minimize WACC. The boardroom wants financial flexibility and distance from financial peril. Investors want near-term returns. Rating agencies want guardrails. Activists say you are wrong. And the CEO has opinions. We are also in an era where hyperscalers are committing hundreds of billions to AI infrastructure, and there the conversation reframes again: Capital structure becomes a tool for funding transformational growth and staking a claim to a lucrative market at speed, not merely a WACC minimization exercise. At HP, capital structure was central to how we competed. When Xerox and Carl Icahn launched a hostile takeover, we committed $16 billion in shareholder returns over three years, roughly half of market cap, while maintaining investment-grade credit at 1.5x to 2.0x debt to EBITDA. Earlier, when HP separated into two companies, we stood up two distinct, optimal capital structures, each calibrated to the business, its cyclicality and its rating profile. Neither outcome was improvised. Both reflected years of analytical work on the ideal capital structure, deep relationships with rating agencies, scenario planning for downturns, and a board that understood the trade-offs. Capital structure theories (Modigliani-Miller, the trade-off model, pecking order) provide useful frameworks. But real-world decisions require integrating theory with executive priorities, board viewpoints, competitive dynamics, rating agency realities and capital market conditions that shift constantly. Getting this right is core to the treasurer's job. Here are five strategic questions for CFOs, treasurers and boards. I’ll share five more next week. Analytical Foundation: Cost of Capital, Ratings, Liquidity

1. Have you done the analytical work to determine where your WACC is minimized, across both the cost of debt and the cost of equity, and what that implies for your target capital structure and credit rating? Pro tip: The textbook says debt is cheaper than equity until bankruptcy risk drives the cost of debt high enough to reverse the benefit. This is directionally correct but practically useless. In real capital markets, the inflection points are not smooth curves. They are cliffs, and they shift with market conditions. There are two commercial paper cliffs treasurers need to map. The first is falling from a credit rating of A1/P1 to A2/P2 and finding a much shallower investor base and materially wider pricing. The second is the loss of investment-grade status, which is effectively losing CP market access. Both cliffs reprice your funding stack and reshape your investor mix overnight. These are structural features of how capital markets work. Management of the margins matters, so know where your cliffs are, build a buffer above them so you are prepared for adverse markets, and manage the levers that compress both halves of WACC. Also look at the opposite. If you are just below a cliff, it’s incumbent on you to find your way to the top given the interest savings and financial flexibility you’ll find there. The reality is that while most treasurers can quote their cost of debt to the basis point, few can articulate the cost of equity with the same precision. Practically, it is reflected in valuation multiples. A company trading at 8x earnings has an implied cost of equity far higher than one at 12x that’s growing at the same rate. That point is critical: high-growth technology companies have equity costs that contain embedded growth expectations, reinvestment rates and optionality values that also drive the implied cost of equity in those names. Cash flow is the conduit that connects capital structure to equity value. Free cash flow can be managed through working capital discipline, capital allocation rigor and operational efficiency in ways that directly influence how the market prices your equity. Today, some companies with real market power are raising large amounts of equity rather than carefully looking at their working capital as a source of funds. That is a missed opportunity. Between pure debt and pure equity sits a continuum of hybrids—preferred stock, perpetuals, convertibles—that can earn partial equity credit from rating agencies (often 50%) while pricing closer to debt, giving treasurers a third lever to tune WACC against ratings headroom. Beyond the classic hybrids, structured instruments—sale-leasebacks, project finance, joint ventures and private credit—deserve a seat at the same table. For hyperscaler issuers financing massive AI infrastructure builds at scale, these structures are where the real innovation is happening: They preserve balance sheet capacity, align funding tenor with asset life and create optionality that pure debt or equity choices cannot. A good exercise: Model your WACC across a range of leverage ratios, anchored to real-world breakpoints where CP access degrades, bond spreads gap wider, your investor base shifts and the equity multiple compresses. Understand the impact of hitting a ratings/debt cost cliff in both good and bad market environments. Most importantly, make sure the CEO, CFO and board understand and support the strategy as one that is aligned with their growth objectives.

2. Do you have a cohesive strategy for engaging with credit rating agencies? Pro tip: Rating agency relationships are not unlike investor relations. You need a narrative, credibility and consistency. The level of touch should be proportional to your proximity to a ratings outcome. If you are comfortably mid-BBB with a stable outlook, an annual meeting plus a quarterly update may suffice. If you are near a downgrade threshold or pursuing a transaction, you should be on the phone proactively, walking analysts through your business dynamics, addressing methodology-specific concerns and making sure the CFO is on the call when the chips are down. When HP separated into two Fortune 50 companies, we conducted a full ratings advisory process, engaged all three agencies months ahead and established capital structures that achieved dual BBB+ ratings for both entities. That did not happen by sending a press release. We took analysts through the business model in detail, segment by segment. Some companies sit at sub-investment-grade ratings that could be higher if they invested the time to improve understanding of their fundamentals. Ratings are partly quantitative (leverage, coverage, cash flow), but the qualitative overlay (management credibility, financial policy clarity, willingness to engage) matters enormously. Understand ratings analyst methodology, speak their language and build the relationship before you need it. 3. How well do you understand the interest rate sensitivity of your balance sheet, and are you actively managing asset-liability mismatches? Pro tip: Asset-liability management in a corporate context is less discussed than in banking, but no less important. Run a sensitivity analysis: What happens to net interest expense, pension funded status and operating margins if rates move 100, 200 or 300 basis points in either direction? At HP, we managed $14 billion in pension assets alongside our debt stack. When I started, a 100-basis-point move could shift pension funded status by hundreds of millions and alter debt service costs materially. By understanding those dynamics, we used swaps to recalibrate our mix of fixed- to floating-rate debt, reducing interest expense and lowering interest rate sensitivity. We also altered pension duration and asset allocation to better match assets and liabilities, reducing risk while improving returns. Understand your interest rate risk by modeling the sensitivity of your P&L and balance sheet to rate changes across scenarios, and then determine whether swaps, callable structures or natural hedging through your operating model are the most efficient approach to manage your risk. The same discipline applies across currencies; issuing debt in the currencies where you generate cash flow and hold net investments creates a natural hedge against translation exposure and reduces reliance on the cross-currency swap market, which tends to dislocate precisely when you need it most. Treat the balance sheet as an integrated whole and make your interest rate sensitivity choice consciously. 4. How clearly have you articulated your capital structure objectives to the investment community? Pro tip: Investors demand clarity on capital allocation and capital structure. Ambiguity invites someone else to define your framework for you. Explicit commitments (a 2.0x to 2.5x leverage band, a 75% free cash flow return target, conditions under which debt will rise for an acquisition) provide clarity but also reduce flexibility. The right level of specificity depends on where you sit in the corporate lifecycle: More mature companies must operate with more defined policies because the market will assume the worst in the absence of them. Activists exploit holes in logic or the absence of any logic. When a business struggles, a company without a clearly articulated capital allocation framework becomes a target. The activist's pitch is simple: “Management has no framework; we do—and ours returns more cash to shareholders.” Today’s activist landscape has also expanded beyond under-returning industrials to over-capitalized technology companies sitting on cash and underleveraged balance sheets, so the framework needs to defend both directions. Clearly articulate a strategy that optimizes returns and build a track record of execution consistent with the policy. The best defense is a good offense: Do the analysis, own the narrative and communicate with conviction. 5. Do you know how your business and capital structure will respond in an economic downturn, and have you stress-tested your liquidity sources? Pro tip: Every company plans for growth. Far fewer plan rigorously for contraction. To do that, answer the questions that matter:

If revenue drops 15% to 25%, how fast does cash flow deteriorate?

If commercial paper access is cut off, either because your rating slips or because the market freezes as it did in 2008, how much revolver capacity do you have?

Are your revolver covenants set at levels that survive a recession, or will a downturn trigger a technical default at exactly the wrong moment?

Post-Covid, the relevant scenarios also extend beyond revenue declines to tariff shocks, regulatory fragmentation and supply-chain disruptions where capex commitments are contractually locked while revenue assumptions shift underneath you. Before Covid, HP ran simulations on how cash flow would respond to significant business deterioration. When the pandemic hit, we already had a playbook. Knowing the game plan opened opportunities to win in the market that would not have existed without that planning.

The capital structure implications of a downturn compound. Revenue falls, working capital may consume cash, ratings come under pressure, borrowing costs rise, and access to short-term funding narrows—all simultaneously. Map this cascade. Know your revolver capacity, your CP backup, your covenant headroom and your ability to pull discretionary levers (capex, buybacks, factoring, dividends) quickly. The treasurer who has done this work becomes indispensable in a crisis. The one who has not becomes a liability and sometimes finds themselves unemployed.

Next week, in part two, I will address stakeholder management and governance as well as market dynamics, execution and strategic positioning. Finally, I’ll share my insights on the need for treasurers to drive the outcome.

A Capital Structure Strategy Designed for Winning

Former HP treasurer and NeuGroup member Zac Nesper shares questions that unlock corporate treasury's full value to the enterprise. Today's focus: part one of his insights on capital structure strategy.

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