Marriott Corporation

This case describes management's sequential reevaluation of Marriott's debt capacity and the decision about how to invest this unused debt. Videotape #5556, "Strategic Leadership," is designed for use with this case (see Videotape Bibliography). Excerpt UVA-F-0477 MARRIOTT CORPORATION In January 1980, the management of Marriott Corporation (MC) faced an interesting dilemma: not only did the corporation have considerable excess debt capacity, but projections of future operations and cash flows indicated that this capacity would increase during the upcoming year. Management had stated that unused debt capacity was inconsistent with the goal of maximizing shareholder wealth. Excess debt capacity was viewed as comparable to unused plant capacity because the existing equity base could support additional productive assets. Management's negative view of excess debt capacity had been strengthened by the rising inflation rates of the late 1970s, which were thought to increase the costs of unused debt capacity, both directly and indirectly. As stated in MC's 1979 annual report: Both the cost of equity and the cost of debt increase with inflation. However, as inflation accelerates, tax deductibility partially offsets the rising cost of debt. On the other hand, business absorbs the full inflationary impact of equity cost increases. A firm which prudently utilizes its full debt capacity substitutes marginally cheaper debt for more expensive equity, thus optimizing the weighted-cost of capital. High inflation rates also had subtle effects on a firm's capital structure. Measured by its current value, debt previously committed at comparatively low interest rates actually declined in value. When the company's balance sheet was recast on a current-value basis, the debt-to-total-capital ratio actually declined, implying an increase in debt capacity. . . .