Synopses & Reviews
This is an academic text in Business Valuation, which is a sub-field of Economics. Excerpts... Business appraisers who seek substantive answers to common valuation questions, questions that may not have been adequately answered in the current business valuation literature, may find this text engaging, informative and thought-provoking (p. v). For practitioners who would like to provide substantive, compelling, and convincing support for their deviations from generally accepted business valuation practice, in order to meet a Daubert Challenge for example, this text may provide a useful resource (p. iv). For academic economists, especially those looking for instructive real world examples of Applied Microeconomics, this text may provide several examples of how economic theory is applied in business valuation practice (p. v). Financial economists may find the author's analysis and conclusions regarding a competitive asset market risk-return relationship, which is discussed in the context of the Traditional CAPM, to be controversial, yet thought-provoking (p. vi). Economics underlies much of business valuation theory and practice, yet there appears to be surprisingly little explanation of how it fits into and underlies the typical business valuation analysis. Indeed, analyses of market value are inextricably linked to an underlying foundation of Economics, since market value (and price) is a function of the interaction of market supply and demand (p. v). ...the typical absence of an explicit Fair Market supply and demand analysis of the DLOM, one which is consistent with accepted economic theory...raises a red flag. The present author does not see how one can sufficiently support a claim that one's DLOM analysis produces a Hypothetical Fair Market discount when an explicit (or even a readily-apparent implicit) analysis of the Hypothetical Fair Market (i.e., Hypothetical Market supply and demand curves) is not performed (p. 285). From a larger perspective, this text attempts to link and integrate business valuation theory and practice with its economic underpinnings in formal and explicit ways (p. v). Consistent with the present author's view, Markowitz (2008)...concludes that it is inaccurate to interpret the Traditional CAPM's positive, linear relation between expected beta risk and expected return as indicating or meaning that 'CAPM investors are paid for bearing systematic risk' (p. 91) (p. 362). ...risk-loving investors are willing to take on the extra risk in return for the opportunity to earn a higher rate of return that was created by a higher up-side variance in Asset 1's normal probability distribution. That does not mean that risk-loving investors 'require', or even expect, that they will earn a higher up-side rate of return. There is no certainty that anyone will earn a higher rate of return on assets with higher systematic risk... (p. 388). Notice that there is no universal rule or expectation of receiving a higher rate of return on an investment in the more risky asset. The opportunity, which is not a certainty, to earn a possible higher rate of return is reserved for only those investors who are quick enough to purchase Asset 1 before Asset 1's price has a chance to adjust fully upward to its new equilibrium level that is commensurate with its now-higher systematic risk (p. 390). if a positive risk-return relationship is not representative of the adjustment process toward a new competitive asset market equilibrium, a Fair Market DLOM may be unfounded. The present author has shown that, when one assumes that a competitive asset market includes heterogeneous investors (risk-loving as well as risk-averse investors), where risk-loving investors' aggregate response can dominate that of risk-averse investors, ...a competitive asset market may exhibit a negative risk-return relationship (pp. 396-397).
Synopsis
"Appraisers often...overlook or ignore important elements of meaning and nuance... , i.e., ] the valuation implications of the standard of value known as fair market value" (Mercer and Brown 1999a, p.16). Bonbright (1937), a recognized authority in valuation, acknowledged the "necessity of a fairly precise definition of value" (p.125) and the importance of "distinction, in all its implications, clearly recognized" between concepts of value (p.16) as a necessary "prerequisite to the intelligent discussion of the evidence" or "proof" of value (p.125), noting the imprecise nature of such "question-begging phrases as 'fair market value, ' or 'price at which the property would be sold by a willing seller to a willing buyer'" (p.236). He did not object to the fictitious hypothetical nature of the Fair Market Value Standard (FMVS), but rather to its imprecise definition, inconsistent application, and the characteristic failure to properly distinguish between concepts of value. Appraisal experts and courts recognize that that imprecision and inconsistency often stems from a failure to recognize the logical implications of the FMVS's assumptions (Mercer and Brown 1999a; Fishman and O'Rourke 1998; Fishman, Pratt and Morrison 2007; Bank One Corp. v. Commissioner (120 T.C. 11 (2003)). Subjective valuation adjustments for non-systematic risk are applied because real-world investors are not financially able to diversify well and require a DLOM for non-systematic risk, effectively not recognizing the difference between the Hypothetical Market Construct (within which Hypothetical Investors hypothetically invest) and real-world market (within which real-world investors actually invest). A consistent application of the FMVS's assumptions in appraisal practice defines Hypothetical Investors, by logical implication of those assumptions, as owners of well-diversified asset portfolios who require no form of non-systematic risk valuation discount (Chapter 3). How can one calculate a reliable Fair Market discount for lack of marketability (DLOM) when an explicit, or even a readily-apparent implicit, supply and demand analysis of the Hypothetical Market is not performed? Market value is founded on supply and demand and underlying factors that determine them. Without the guiding valuation structure that Economics' supply and demand framework provides, appraisers have excess leeway to apply inherently arbitrary subjective valuation adjustments, necessarily reducing the reliability of FMV appraisals. Subjective valuation adjustments allow flexibility to account for qualitative valuation factors not captured in the quantitative analysis, yet also create opportunities to advocate for a client's desired value conclusion, that advocacy being the natural result of client pressure for advocacy combined with appraisers' profit incentive to succumb to that pressure (Chapter 10). Advocacy concerns are justified because "Subjective valuation steps are, by definition, not objective"(p. 239) and cannot be made objectively even by well-intentioned appraisers using "informed judgment" based on years of professional experience. The explicit supply and demand analysis in Chapter 13 shows that, contrary to the long-standing practice of applying DLOMs, a small premium for lack of marketability (PLOM), rather than a DLOM, is the Fair Market result. The author's analyses are not, by any measure, mere exercises in abstract theory. That his conclusions are not generally accepted does not undermine their credibility or significance. His assumptions (which are the FMVS's assumptions), economic analyses, and conclusions fully stand on their own merits. Eldridge's (2012) book review concludes "Dawson has provided careful analyses and discussions that challenge professional appraisers' common practice of applying extensive DLOM in valuing minority interests in closely-held businesses" (p.139).