Professional Documents
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Business Valuation Upon Divorce: How Theory and Practice Can Lead To Problems in Court
Business Valuation Upon Divorce: How Theory and Practice Can Lead To Problems in Court
Richard R. Orsinger
[email protected]
http://www.orsinger.com
Orsinger, Nelson, Downing & Anderson, LLP
San Antonio Office:
1717 Tower Life Building
San Antonio, Texas 78205
(210) 225-5567
http://www.orsinger.com
and
Dallas Office:
5950 Sherry Lane, Suite 800
Dallas, Texas 75225
(214) 273-2400
http://www.ondafamilylaw.com
2012
Richard R. Orsinger
All Rights Reserved
Licensed:
Texas Supreme Court (1975); U.S. District Court, Western District of Texas (1977-1992; 2000-present); U.S.
District Court, Southern District of Texas (1979); U.S. Court of Appeals, Fifth Circuit (1979); U.S. Supreme
Court (1981)
Certified:
Board Certified by the Texas Board of Legal Specialization Family Law (1980), Civil Appellate Law (1987)
Computer Workshop at Advanced Family Law (1990-94) and Advanced Civil Trial (1990-91) courses
1987 Advanced Family Law Course. Course Director, Texas Academy of Family Law Specialists First Annual Trial Institute,
Las Vegas, Nevada (1987)
Books and Journal Articles:
Editor-in-Chief of the State Bar of Texas TEXAS SUPREME COURT PRACTICE MANUAL (2005)
Chief Editor of the State Bar of Texas Family Law Section's EXPERT WITNESS MANUAL (Vols. II & III) (1999)
Author of Vol. 6 of McDonald Texas Civil Practice, on Texas Civil Appellate Practice, published by Bancroft-Whitney Co.
(1992) (900 + pages)
A Guide to Proceedings Under the Texas Parent Notification Statute and Rules, SOUTH TEXAS LAW REVIEW (2000) (coauthored)
Obligations of the Trial Lawyer Under Texas Law Toward the Client Relating to an Appeal, 41 SOUTH TEXAS LAW REVIEW
111 (1999)
Asserting Claims for Intentionally or Recklessly Causing Severe Emotional Distress, in Connection With a Divorce, 25 ST.
MARY'S L.J. 1253 (1994), republished in the AMERICAN JOURNAL OF FAMILY LAW (Fall 1994) and Texas Family Law Service
NewsAlert (Oct. & Dec., 1994 and Feb., 1995)
Chapter 21 on Business Interests in Bancroft-Whitney's TEXAS FAMILY LAW SERVICE (Speer's 6th ed.)
Characterization of Marital Property, 39 BAY. L. REV. 909 (1988) (co-authored)
Fitting a Round Peg Into A Square Hole: Section 3.63, Texas Family Code, and the Marriage That Crosses States Lines, 13
ST. MARY'S L.J. 477 (1982)
SELECTED CLE SPEECHES AND ARTICLES
State Bar of Texas' [SBOT] Advanced Family Law Course: Intra and Inter Family
Transactions (1983); Handling the Appeal: Procedures and Pitfalls (1984); Methods and
Tools of Discovery (1985); Characterization and Reimbursement (1986); Trusts and
Family Law (1986); The Family Law Case in the Appellate Court (1987); Post-Divorce
Division of Property (1988); Marital Agreements: Enforcement and Defense (1989);
Marital Liabilities (1990); Rules of Procedure (1991); Valuation Overview (1992);
Deposition Use in Trial: Cassette Tapes, Video, Audio, Reading and Editing (1993); The
Great Debate: Dividing Goodwill on Divorce (1994); Characterization (1995); Ordinary
Reimbursement and Creative Theories of Reimbursement (1996); Qualifying and
Rejecting Expert Witnesses (1997); New Developments in Civil Procedure and Evidence
(1998); The Expert Witness Manual (1999); Reimbursement in the 21st Century (2000);
Personal Goodwill vs. Commercial Goodwill: A Case Study (2000); What Representing
the Judge or Contributing to Her Campaign Can Mean to Your Client: Proposed New
Disqualification and Recusal Rules (2001); Tax Workshop: The Fundamentals (2001);
Blue Sky or Book Value? Complex Issues in Business Valuation (2001); Private Justice:
Arbitration as an Alternative to the Courthouse (2002); International & Cross Border
Issues (2002); Premarital and Marital Agreements: Representing the Non-Monied Spouse
(2003); Those Other Texas Codes: Things the Family Lawyer Needs to Know About
Codifications Outside the Family Code (2004); Pearls of Wisdom From Thirty Years of
Practicing Family Law (2005); The Road Ahead: Long-Term Financial Planning in
Connection With Divorce (2006); A New Approach to Distinguishing Enterprise
Goodwill From Personal Goodwill (2007); The Law of Interpreting Contracts: How to
Draft Contracts to Avoid or Win Litigation (2008); Effect of Choice of Entities: How
Organizational Law, Accounting, and Tax Law for Entities Affect Marital Property Law
(2008); Practicing Family Law in a Depressed Economy, Parts I & II (2009); Property
Puzzles: 30 Characterization Rules, Explanations & Examples (2009); Troubling Issues
of Characterization, Reimbursement, Valuation, and Division Upon Divorce (2010);
Separate & Community Property: 30 Rules With Explanations & Examples (2010); The
Role of Reasoning in Constructing a Persuasive Argument (2011)
UT School of Law: Trusts in Texas Law: What Are the Community Rights in
Separately Created Trusts? (1985); Partnerships and Family Law (1986); Proving Up
Separate and Community Property Claims Through Tracing (1987); Appealing Non-Jury
Cases in State Court (1991); The New (Proposed) Texas Rules of Appellate Procedure
(1995); The Effective Motion for Rehearing (1996); Intellectual Property (1997);
Preservation of Error Update (1997); TRAPs Under the New T.R.A.P. (1998); Judicial
Perspectives on Appellate Practice (2000)
SBOT's Advanced Evidence & Discovery Course: Successful Mandamus Approaches
in Discovery (1988); Mandamus (1989); Preservation of Privileges, Exemptions and
Objections (1990); Business and Public Records (1993); Grab Bag: Evidence &
Discovery (1993); Common Evidence Problems (1994); Managing Documents--The
Technology (1996); Evidence Grab Bag (1997); Evidence Grab Bag (1998); Making and
Meeting Objections (1998-99); Evidentiary Issues Surrounding Expert Witnesses (1999);
Predicates and Objections (2000); Predicates and Objections (2001); Building Blocks of
Evidence (2002); Strategies in Making a Daubert Attack (2002); Predicates and
Objections (2002); Building Blocks of Evidence (2003); Predicates & Objections (High
Tech Emphasis) (2003)
SBOT's Advanced Civil Appellate Practice Course: Handling the Appeal from a
Bench Trial in a Civil Case (1989); Appeal of Non-Jury Trials (1990); Successful
Challenges to Legal/Factual Sufficiency (1991); In the Sup. Ct.: Reversing the Court of
Appeals (1992); Brief Writing: Creatively Crafting for the Reader (1993); Interlocutory
and Accelerated Appeals (1994); Non-Jury Appeals (1995); Technology and the
Courtroom of the Future (1996); Are Non-Jury Trials Ever "Appealing"? (1998);
Enforcing the Judgment, Including While on Appeal (1998); Judges vs. Juries: A Debate
(2000); Appellate Squares (2000); Texas Supreme Court Trends (2002); New Appellate
Rules and New Trial Rules (2003); Supreme Court Trends (2004); Recent Developments in the Daubert Swamp (2005); Hot Topics in Litigation: Restitution/Unjust
Enrichment (2006); The Law of Interpreting Contracts (2007); Judicial Review of
Arbitration Rulings: Problems and Possible Alternatives (2008); The Role of Reasoning
and Persuasion in the Legal Process (2010)
Various CLE Providers: SBOT Advanced Civil Trial Course: Judgment Enforcement,
Turnover and Contempt (1990-1991), Offering and Excluding Evidence (1995), New
Appellate Rules (1997), The Communications Revolution: Portability, The Internet and
the Practice of Law (1998), Daubert With Emphasis on Commercial Litigation,
Damages, and the NonScientific Expert (2000), Rules/Legislation Preview (State
Perspective) (2002); College of Advanced Judicial Studies: Evidentiary Issues (2001);
El Paso Family Law Bar Assn: Foreign Law and Foreign Evidence (2001); American
Institute of Certified Public Accounts: Admissibility of Lay and Expert Testimony;
General Acceptance Versus Daubert (2002); Texas and Louisiana Associations of
Defense Counsel: Use of Fact Witnesses, Lay Opinion, and Expert Testimony; When and
How to Raise a Daubert Challenge (2002); SBOT In-House Counsel Course: Marital
Property Rights in Corporate Benefits for High-Level Employees (2002); SBOT 19th
Annual Litigation Update Institute: Distinguishing Fact Testimony, Lay Opinion &
Expert Testimony; Raising a Daubert Challenge (2003); State Bar College Spring
Training: Current Events in Family Law (2003); SBOT Practice Before the Supreme
Court: Texas Supreme Court Trends (2003); SBOT 26th Annual Advanced Civil Trial:
Distinguishing Fact Testimony, Lay Opinion & Expert Testimony; Challenging
Qualifications, Reliability, and Underlying Data (2003); SBOT New Frontiers in Marital
Property: Busting Trusts Upon Divorce (2003); American Academy of Psychiatry and the
Law: Daubert, Kumho Tire and the Forensic Child Expert (2003); AICPA-AAML
National Conference on Divorce: Cutting Edge IssuesNew Alimony Theories;
Measuring Personal Goodwill (2006); New Frontiers` - Distinguishing Enterprise
Goodwill from Personal Goodwill; Judicial Conference (2006); SBOT New Frontiers in
Marital Property Law: Tracing, Reimbursement and Economic Contribution Claims In
Brokerage Accounts (2007); SBOT In-House Counsel Course: When an Officer
Divorces: How a Company can be Affected by an Officers Divorce (2009); SBOT
Handling Your First Civil Appeal The Role of Reasoning and Persuasion in Appeals
(2011); New Frontiers in Marital Property Law: A New Approach to Determining
Enterprise and Personal Goodwill Upon Divorce (2011)
TABLE OF CONTENTS
I. INTRODUCTION.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
II. STANDARDS OF VALUE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
A. FAIR MARKET VALUE... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
1. Definitions of Fair Market Value.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
2. Inputs in Determining Fair Market Value.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
3. Rev. Ruling 59-60's Fair Market Value of a Privately-Owned Business.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
B. FAIR VALUE (ACCOUNTING)... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
1. Definition of Fair Value (Accounting).. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
2. Inputs for Determining Fair Value (Accounting)... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
C. FAIR VALUE (DISSENTERS RIGHTS)... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
1. Colorado.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
2. California.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 8
3. Colorado.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
4. Delaware.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9
5. Illinois.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
6. Iowa.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
7. Kansas.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
8. Kentucky.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 10
9. Maine.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
10. New Jersey.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
11. New York.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
12. Texas... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
13. Vermont.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11
14. Wyoming... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
15. Whats Fair?.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
D. ANALOGY TO DIVORCE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 12
E. INTRINSIC VALUE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
1. What is Intrinsic Value?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
F. INVESTMENT VALUE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 13
G. LIQUIDATION VALUE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
H. BOOK VALUE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
I. GOING CONCERN VALUE... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 14
J. SENTIMENTAL VALUE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
K. STANDARD OF VALUE FOR DIVORCE.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Alabama... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Arizona.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 15
Arkansas.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
California... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Colorado.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Connecticut.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Delaware.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Florida.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Hawaii.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Idaho.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Illinois.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 16
Indiana.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Iowa.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Kansas.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Mississippi... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17
Missouri... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New York.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New Jersey... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New Mexico.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
North Carolina.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
North Dakota.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Ohio... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Oklahoma.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pennsylvania.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
South Carolina.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tennessee.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Texas.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Vermont... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Virginia.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
West Virginia... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Wisconsin.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
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8. Circularity. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
9. The Breakpoints Between Deciles.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
10. Size Premia are Historical.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
11. Size Versus Liquidity Premium?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
12. Are There Better Measures of Risk Than Size?. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
L. PROBLEMS WITH THE INDUSTRY RISK PREMIUM.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
M. SHOULD THERE BE A LIQUIDITY PREMIUM?.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
N. PROBLEMS WITH THE SPECIFIC COMPANY RISK PREMIUM... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
53
54
54
54
54
54
54
55
56
56
57
58
58
58
58
iv
72
72
72
72
73
73
73
73
73
74
74
New Hampshire.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New Mexico.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New Jersey... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
New York.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Oklahoma.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Oregon.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Pennsylvania.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
South Dakota.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Tennessee.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Texas.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Utah.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Virginia.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
Washington.. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
West Virginia... . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
74
74
74
75
75
75
75
75
75
75
76
76
76
76
77
78
78
80
80
80
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
A. FAIR MARKET VALUE. In the business valuation field, the idea of value is dominated by the definition that the U.S. Government requires for tax purposes:
fair market value.
1. Definitions of Fair Market Value. Treasury
Regulation 20.2031-1(b) defines "fair market value" in
this way:
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
The fair market value of a particular item of property includible in the decedent's gross estate is not
to be determined by a forced sale price. Nor is the
fair market value of an item of property to be
determined by the sale price of the item in a market other than that in which such item is most
commonly sold to the public, taking into account
the location of the item wherever appropriate.
Id.
In United States v. Cartwright, 411 U.S. 546, 550-51
(1973), the U.S. Supreme Court said:
In implementing 26 U.S.C. 2031, the general
principle of the Treasury Regulations is that the
value of property is to be determined by its fair
market value at the time of the decedent's death.
The fair market value is the price at which the
property would change hands between a willing
buyer and a willing seller, neither being under any
compulsion to buy or to sell and both having
reasonable knowledge of relevant facts. Treas.
Reg. 20.2031-1(b). The willing buyer-willing
seller test of fair market value is nearly as old as
the federal income, estate, and gifts taxes themselves, and is not challenged here.FN7 Under this
test, it is clear that if the decedent had owned
ordinary corporate stock listed on an exchange, its
value' for estate tax purposes would be the price
the estate could have obtained if it had sold the
stock on the valuation date, that price being, under
Treas. Reg. 20.2031-2(b), the mean between the
highest and lowest quoted selling prices on that
day.
2. Inputs in Determining Fair Market Value. The
IRS Regulations set out a hierarchy of information to be
considered in estimating fair market value for estate and
gift tax purposes. The more reliable indicators of value
must be used if they are available; if none are available,
then the next highest level of indicator should be used,
and so on, in descending order. Subdivision (f) covers
closely-held business interests that has had no recent
arms length sales.
IRS Regulation 20.2031-2 Valuation of stocks
and bonds.
(a) In general. The value of stocks and
bonds is the fair market value per share or bond on
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
It is interesting to note that the Treasury Regs description of factors to consider, when there is no market data
from which to draw value inferences, is very much like
Intrinsic Value. See Section II.D.
B.
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
2. Inputs for Determining Fair Value (Accounting). The accounting profession has developed its own
hierarchy of indicators of fair market value to be used by
accountants when they are valuing assets (and liabilities)
to be listed on a financial statement (like a balance sheet
or statement of assets and liabilities). Take care to note
that the accounting profession uses the term "fair value"
to mean what lawyers mean when lawyers say "fair
market value."
In the USA, the ultimate authority on Generally Accepted Accounting Principles (GAAP) is the Financial
Accounting Standards Board (FASB). In September
2006, FASB promulgated Financial Accounting Standard 157 ("FAS 157"). The document can be found at
<http://www.fasb.org/pdf/fas157.pdf>. FAS 157 established a hierarchy of information to use in determining
the "fair value" of assets or liabilities under Generally
Accepted Accounting Practices (GAAP).
Here is the Federal Reserve Bank of New York's summary of FAS 157:
FASB Statement No. 157, Fair Value Measurements (FAS 157), issued in September 2006,
defines fair value, establishes a framework for
measuring the fair value of assets and liabilities
based on a three level hierarchy, and expands
disclosures about fair value measurements. The
FASB's three-level fair value hierarchy gives the
highest priority to quoted prices in active markets
for identical assets or liabilities (Level 1) and the
lowest priority to unobservable inputs (Level 3).
Level 1 inputs are quoted prices in active markets
for identical assets or liabilities that the reporting
branch or agency has the ability to access at the
measurement date (e.g., the FFIEC 002 reporting
date). Level 2 inputs are inputs other than quoted
prices included within Level 1 that are observable
for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for
the asset or liability. 3
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Level 1 inputs
24. Level 1 inputs are quoted prices (unadjusted) in active markets for identical assets or
liabilities that the reporting entity has the ability to
access at the measurement date. An active market
for the asset or liability is a market in which
transactions for the asset or liability occur with
sufficient frequency and volume to provide pricing
information on an ongoing basis. A quoted price in
an active market provides the most reliable evidence of fair value and shall be used to measure
fair value whenever available, except as discussed
in paragraphs 25 and 26.
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Level 3 inputs
30. Level 3 inputs are unobservable inputs
for the asset or liability. Unobservable inputs shall
be used to measure fair value to the extent that
observable inputs are not available, thereby allowing for situations in which there is little, if any,
market activity for the asset or liability at the
measurement date. However, the fair value measurement objective remains the same, that is, an
exit price from the perspective of a market participant that holds the asset or owes the liability.
Therefore, un-observable inputs shall reflect the
reporting entity's own assumptions about the
assumptions that market participants would use in
pricing the asset or liability (including assumptions
about risk). Unobservable inputs shall be developed based on the best information available in the
circumstances, which might include the reporting
entity's own data. In developing unobservable
inputs, the reporting entity need not undertake all
possible efforts to obtain information about market
participant assumptions. However, the reporting
entity shall not ignore information about market
participant assumptions that is reasonably available without undue cost and effort. Therefore, the
reporting entity's own data used to develop
unobservable inputs shall be adjusted if information is reasonably available without undue cost and
effort that indicates that market participants would
use different assumptions.
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
(a) Subject to any contrary provision in the articles, in any suit for involuntary dissolution, or in
any proceeding for voluntary dissolution initiated
by the vote of shareholders representing only 50
percent of the voting power, the corporation or, if
it does not elect to purchase, the holders of 50
percent or more of the voting power of the corporation (the purchasing parties) may avoid the
dissolution of the corporation and the appointment
of any receiver by purchasing for cash the shares
owned by the plaintiffs or by the shareholders so
initiating the proceeding (the moving parties) at
their fair value. The fair value shall be determined
on the basis of the liquidation value as of the
valuation date but taking into account the possibility, if any, of sale of the entire business as a going
concern in a liquidation. . . .
California case law construing section 2000 approves the use of a hypothetical sale model, like
the one employed by the appraisers in this case, to
calculate the fair value of a corporation that can be
sold as a going concern in liquidation. (Abrams,
supra, 114 Cal.App.3d at pp., 248249, 170
Cal.Rptr. 656 (Abrams).) In Abrams, the court held
that appraisers who conducted a section 2000 fair
value determination acted properly by assuming
that the owners of the corporation would have
agreed not to compete with the corporation after it
was sold as a going concern in liquidation. (Abrams, supra, 114 Cal.App.3d 240, 170 Cal.Rptr.
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
The Court in Cavalier made this important point regarding the fact that a hypothetical sale is not the paradigm
for dissenters rights:
The application of a discount to a minority shareholder is contrary to the requirement that the
company be viewed as a going concern. Cavalier's argument, that the only way Harnett would
have received value for his 1.5% stock interest was
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
10
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
(b) In computing the fair value of an ownership interest under this subchapter, consideration
11
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
12
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
INTRINSIC VALUE.
1. What is Intrinsic Value? Ibbotson defines "Intrinsic Value" as "the value that an investor considers, on
the basis of an evaluation or available facts, to be the
true' or real' value that will become the market value
when other investors reach the same conclusion."
IBBOTSON SBBI 2011 VALUATION YEARBOOK p. 12.
The Intrinsic Value of a company is the value of a
company determined from an analysis of its true value,
as distinguished from the value that is recognized by
others, as reflected in the marketplace. Intrinsic Value
involves all aspects of the business, tangible and intangible. Intrinsic Value may or may not equate to Fair
Market Value, since Fair Market Value represents the
prevailing view of value of the business, or its value in
exchange and not its actual value.
Warren Buffett described Intrinsic Value in this way:
Intrinsic value is an all-important concept that
offers the only logical approach to evaluating the
relative attractiveness of investments and businesses. Intrinsic value can be defined simply: It is
the discounted value of the cash that can be taken
out of a business during its remaining life.
*
*
*
The calculation of intrinsic value, though, is not so
simple. As our definition suggests, intrinsic value
is an estimate rather than a precise figure, and it is
additionally an estimate that must be changed if
interest rates move or forecasts of future cash
flows are revised. Two people looking at the same
set of facts, moreover and this would apply even
to Charlie and me will almost inevitably come up
with at least slightly different intrinsic value
figures. That is one reason we never give you our
13
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
In some circumstances, book value of inventory may be probative of market value by either
serving as some indication of market value or by
being equivalent to market value. . . . In other
circumstances, the two values may be entirely
unrelated. . . . Whether the book value of inventory
is in fact indicative of or equivalent to its market
value is an issue to be determined by the trier of
fact on a case by case basis. We decline Sears's
invitation to hold that, as a matter of law, inventory book value derived according to generally
accepted accounting principles is not equal to
market value. [Citations omitted.]
I.
GOING CONCERN VALUE. Going Concern
Value is the value of a company viewed as an operating
enterprise. A profitable, functioning business is made up
of individual assets, but the assets taken as a whole are
worth more when they are assembled into a functioning
business than if each asset were to be valued separately.
Going Concern Value at a minimum reflects the cost and
time it would take for someone to assemble a going
concern from replacement assets. But if the business is
profitable, the Going Concern Value reflects not only
14
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
15
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
lated by determining the fair market value of the business, which is the amount a willing buyer and a willing
seller would exchange assets absent duress. . . . Typically, fair market value measures the value of the assets
of the business plus the value of goodwill.
16
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Pennsylvania. Verholek v. Verholek, 741 A.2d 792, 79596 (Pa. Super.1999): Husband's second and third
arguments relate to the trial court's valuation of the 310
shares of Cattron stock. The Divorce Code does not
contain a specific method for valuing assets. The trial
court must exercise its discretion and rely on the estimates, inventories, records of purchase prices, and
appraisals submitted by the parties. . . . The court is free
to accept all, none, or portions of the testimony regarding the true and correct value of property. . . . Additionally, the court may reject evidence offered by both
parties in favor of its own valuation method. [Citations
omitted.]
17
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
valuation.
Virginia. The Supreme Court of Virginia has rejected a
willing buyer/willing seller standard of value for
divorce. In Owens v. Owens, 589 S.E.2d 488, 493 (Va.
2003), the Court stated:
Vermont. In Goodrich v. Goodrich, 613 A.2d 203, 20406 (Vt. 1992), the Supreme Court affirmed a valuation
of a privately-held company based on fair market value,
and endorsed the Revenue Ruling 59-60 approach to
18
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
19
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
See Frye v. U.S., 293 F. 1013 (D.C. Cir. 1923) (establishing the "general acceptance" test for scientific expert
testimony). Under Rule 702, the expert's opinion must
be based on "scientific knowledge," which requires that
it be derived by the scientific method, meaning the
formulation of hypotheses which are verified by experimentation or observation. The Court used the word
"reliability" to describe this necessary quality. The U.S.
Supreme Court's opinion in Daubert applies in all
federal court proceedings.
An application of these evidentiary principles to accounting is reflected in Garnac Grain Co., Inc. v.
Blackley, 932 F.2d 1563 (8th Cir. 1991). There a
corporate client sued its auditors for negligently failing
to conduct audits in accordance with Generally Accepted Auditing Standards (GAAS). The corporation
hired a new auditing firm to review the old auditing
firm's work, and the new auditing firm concluded that
the old auditors failed to adhere to GAAS during the
fiscal year ending 1-1-82. At trial, plaintiff offered the
testimony of an accounting professor who opined that
the auditors violated GAAS for a period of six years, not
just one year. Although the second auditing firm spent
600 hours in arriving at its conclusion as compared to
the 20 hours spent by the professor, and although the
second auditors looked at the first auditors' work papers
while the professor looked only at the second auditors'
report before arriving at his opinion, the appellate court
ruled that the professor's opinion was admissible under
Fed. R. Evid. 702 and 703. The appellate court noted
that the professor later reviewed the first auditors' work
papers and reaffirmed his earlier conclusion. Note that
in Garnac Grain Co., the legal standard of care was
taken to be GAAS; the issue was whether the plaintiff's
experts had the qualifications and used the proper
methodology in determining whether the defendant
breached that standard of care.
20
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
21
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
22
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
23
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
24
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Id. at 14.
In a Discounted Cash Flow (DCF) method, the valuator
separately forecasts the cash flow for each future period
(during the forecast period) until a stable income stream
is achieved (at which point the Terminal Value is
determined). Some writers recommend pushing the
forecast period as far into the future as reliability
permits. Lawrence A. Hamermesh & Michael L.
Wachter, The Short and Puzzling Life of the Implicit
Minority Discount in Delaware Appraisal Law, 156
UNIV. OF PENNSYLVANIA LAW REVIEW 1, 29 (2007)
(Hamermesh).16 However, some business valuators
use an arbitrary cut-off, such as 5 years, to be the point
at which they assume stable income will be achieved.
Foretelling the end of the forecast period involves some
degree of subjectivity. If the firm is presently losing
money, it may still have positive future cash flows in the
future if the current losses are transient, for example if
they are attributable to the spot in the business cycle, or
result from one time charges against profits, or poor
management, or participation in a sector of the economy
that is in its early stages.17
Mercer Capital points out that business valuators assume
either that all cash flows in a year are received midway
through the year, or that the cash flows are received at
the end of the year of the discrete forecast period.
Mercer Capital, A Users Guide to Understanding the
Discounted Future Benefits (Cash Flow) Valuation
Methods.18 Using the mid-year assumption causes some
valuators to discount Terminal Value (see Section IV.D
below) from 4.5 years instead of 5 full years. Id. at 6.
25
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
26
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
27
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
28
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
29
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Panel B of Table 1 presents some summary statistics that pool all 13,668 responses. The overall
average ten-year risk premium return is 3.40%.3
The standard deviation is 3.25%.
Id.
The Graziadio School of Business at Pepperdine University conducts the Pepperdine Private Capital Markets
Project (PPCMP), a survey designed to capture the
thinking of 2,500 business people across the world,
including bankers, venture capitalists, owners of
privately-held businesses, and business valuators.
Survey Report V (Summer 2011). At Figure 26, the
30
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Roger G. Ibbotson, The Equity Risk Premium, RETHINKING THE EQUITY RISK PREMIUM p. 20 (Dec. 23, 2011).54
Admissibility in Court. From a Frye standpoint, the fact
that the use of surveys to establish the ERP is not yet
generally accepted in the business valuation community
is grounds for exclusion. From a Daubert reliability
standpoint, general acceptance is only one of the relevant factors so a lack of general acceptance is not fatal.
However, the fact that the surveys are not yet sufficiently random to be statistically valid creates a risk of
exclusion. Importantly, even imperfect surveys may be
more reliable than formulaic reliance on historical data,
for example if the window of the historical data is too
short to be statistically reliable.
31
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
32
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
2.
E(Ri) = Rf + i ERP
33
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Ks = Rf + (sERP) + SPs
Ks is the expected rate of return on security s, and SPs is
34
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
35
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
36
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
37
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
38
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
39
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
1926-2004
1946-2004
1946-1965
19661981
1982-1999
1982-2004
Compound
Bond
Bill
Simple
Bond Bill
2.25%
1.44
-1.19
-4.17
8.40
8.01
2.77% 0.75
2.04 0.62
-0.95 -0.75
-3.86 -0.13
9.28 2.92
8.74 2.33
0.69%
0.56
-0.84
-0.15
2.91
2.31
40
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
3.31%
3.86%
1802-1870
1871-1925
1926-2004
2.24%
2.89%
4.53%
1946-2004
1946-1965
19661981
1982-1999
1982-2004
5.39%
11.21%
3.81%
5.22%
1.46%
41
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
could have sat out the entire stock market over the last
28 years, parked your money in long-term T-bonds and
done just as well as the stock market, which we know
beats the vast majority of fund managers."107 Thus, long
term rates of return on stocks and government securities
can be affected by the beginning and ending points of
the historical time period (window) you select.
Another problem is that the length of the window affects
the validity of the conclusion. Goetzmann and Ibbotson
have written that a very long time series of stationary
returns is required to achieve a high degree of
confidence in the estimate of the Equity Risk
Premium.108 New York University Professor Aswath
Damodaran (2010) wrote that shorter periods have a
higher standard error, as follows:
5 years
10 years
25 years
50 years
80 years
8.94%
6.32%
4.00%
2.83%
2.23%
42
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
1926-2004 4.53
1946-2004 5.39
1946-1965 11.21
19661981 3.81
1982-1999 5.22
1982-2004 1.46
6.09
6.27
10.86
-0.21
10.71
7.16
6.01 8.02
6.35 7.77
12.34 12.14
5.24 1.51
5.03 1.38
1.90 8.32
geometric
4.29%
2.74%
-7.22%
arithmetic
5.56%
4.09%
-3.68%
43
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Michael W. Barad, of Ibbotson Associates, states Ibbotsons veiw that the ERP to be used in discounting
future cash flows should be calculated using arithmetic
computations. The arithmetic mean takes into account
uncertainty of period-to-period returns. He explains:
The greater the standard deviation for a return series,
the higher the arithmetic mean will be compared to the
geometric mean. This type of period- to-period riskiness
must be accounted for when forecasting. Michael W.
Barad, Ibbotsons Answer.119
44
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
with the Duke CFO Survey, the CFOs believe that the
risk premium is a longer-term measure of expected
excess returns and best covered by our question on the
expected excess return over the next ten years-rather
than the one-year question. Graham & Harvey, The
Equity Risk Premium in 2010 p. 6 (August 9, 2010).124
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45
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
<
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46
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
I.
PROBLEMS WITH BETA. The mathematics of
calculating the Beta coefficient of a publicly-traded
company involves performing a linear regression on
historical total returns of the company compared to
historical total returns of the market as a whole. See
Domantas Skardziukas, Practical Approach to
Estimating Cost of Capital p. 9 (Munich Personal
RePEc Archive, October 1, 2010) (Skardziukas). 134
However, the Betas published by different investment
information services vary. One reason for this is that
these services use different inputs to construct Betas.
Another is that these services make different
adjustments to their Beta calculations, in pursuit of
differing conceptions of accuracy.
47
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
J.
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49
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
As of year 2000, the market cap for the S&P 500 stocks
constitutes 75% of the market cap of all stocks traded on
major U.S. stock exchanges. Id. at 5. A broader index
can be drawn from data maintained by the Center for
Research and Security Prices (CRSP Index). The CRSP
Index included only NYSE stocks from 1926 to 1972; in
1972, the AMEX was added; and in 1973 the NASDAQ
was added. Id. at 5. In 2000, the CRSP Index contained
over 8,000 stocks. Id. at 5. These stock exchanges
include only publicly-traded stocks, whereas many
corporate stocks are not publicly-traded. The FEDs
Board of Governors (BOG) publishes information on all
stocks held by U.S. residents. This information dates
back to 1946. Id. at 5. According to Jagannathan, the
yields on the BOG stocks ran about 1.5% higher than
the S&P 500 or the CRSP until the 1980s, when the
BOG stock yield was 2.5% higher (12.27% vs. 9.8%); in
the 1990s the BOG stock yield was 3% higher (10.84%
vs. 7.84%). Id. at Table 2.
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52
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53
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
54
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55
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
C. COMPARABLE PRIVATELY-OWNED
COMPANIES. In some instances, there may be sales of
other privately-owned companies that are sufficiently
comparable to the subject company to provide useful
multiples. This could include the sale of franchise
operations, professional practices, and other businesses
that belong to a kind of local, regional, or national
market. Unlike publicly-owned companies, privatelyowned companies may require significant effort to
normalize their financial information, and comparability
may be impaired by circumstances peculiar to the
comparable or its sale. Another problem with privatelyowned company transactions is that reliable information
about such companies and the terms of their sale may be
absent for many or most transactions, which reduces the
representativeness of the private transactions that can be
identified and used as comparables. See Carl Lloyd
Sheeler, Business Valuation, pp. 735-36.167
<
<
<
<
Normalization
Identifying multiples
Selecting which multiples to use
Reconciling disparate indicators of value.
58
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
In re Marriage of Hewitson, 142 Cal.App.3d 874, 88586, 191 Cal.Rptr. 392, 398-400 (Cal. App. 2nd Dist.
1983):
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
VIII.
DISCOUNT FOR LACK OF
MARKETABILITY, ADJUSTMENT FOR
CONTROL,
AND
CONTROL
P R E M I U M / M I N O R I T Y D I S CO U N T . In
conventional business appraisal practice, once an
enterprise value is determined many business valuators
will apply a marketability discount to reflect difficulties
in selling a privately-owned business. If partial
ownership interests are to be valued, then a premium is
sometimes added to the controlling interests pro-rata
share of enterprise value and a discount is subtracted
from each minority owners pro-rata share of enterprise
value. Some valuators find an implied minority
discount in publicly-traded stock and add a control
premium to the market prices of comparable guideline
companies when valuing a privately-owned company, or
a controlling interest in a privately-owned company.
There are controversies surrounding these discounts and
premium.
A. D I S C O U N T
FOR
LACK
OF
MARKETABILITY. It is common knowledge,
supported by studies of the data, that investors value
liquidity, and that where two investments are equal in all
respects except that one can more readily be sold than
the other, investors will pay more for the investment that
is easy to sell. This ease in selling is called
marketability or liquidity. Liquidity can be viewed
as the ability to sell an asset for its fair market value
quickly, easily, and at low cost. Mukesh Bajaj, David J.
Denis, Stephen P. Ferris, & Atulya Sarin, Firm Value
and Marketability Discounts 1 (2002) (Bajaj).168
Stocks in companies that are traded on a national
exchange are the epitome of liquidity. Stock in a
privately-owned company is not. Where a fair-marketvalue valuation of a privately-owned business is
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
EBITDA
$250M
$25m
$1m
DLOM for
Controlling
Interest
DLOM for
Minority
Interest
13.98%
16.61%
20.7%
20.29%
23.98%
28.94%
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
63
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
64
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
65
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
68
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Id. at 80.
A comprehensive treatment of the debate over an
Implied Minority Discount and control premia is
contained in Jim Hitchner, 35 FINANCIAL VALUATION
AND LITIGATION EXPERT (Feb./Mar. 2012), pp. 1-14. 195
An extensive analysis of the case law and business
valuation aspects of this question is contained in Gilbert
E. Matthews, Misuse of Control Premiums in Delaware
Appraisals, 27 BUSINESS VALUATION REVIEW 107
(2008).196 Another review of the development of the
Control Premium in Delaware law is William J. Carney
& Mark Heimendinger, Appraising the Nonexistent: The
Delaware Courts Struggle With Control Premiums, 152
UNIV. OF PENNSYLVANIA LAW REVIEW 845 (2003).197 A
review of the law and financial theory that debunks an
Implied Minority Discount is Lawrence A. Hamermesh
& Michael L. Wachter, The Short and Puzzling Life of
the Implicit Minority Discount in Delaware Appraisal
Law, 156 UNIV. OF PENNSYLVANIA LAW REVIEW 1
(2007).198
th
E. APPLICABILITY OF DISCOUNTS TO
DIVORCE VALUATIONS. Different states take
different approaches to the use of the DLOC and DLOM
in divorce valuations.
The Alabama Court of Appeals, in Grelier v. Grelier,
44 So.3d 1092, 1098 (Ala. App. 2009), reversed a trial
court for applying a marketability and a minority
discount to a closely-held business interest.
The Alaska Supreme Court ruled that a minority
discount was allowed in a divorce, in Hayes v. Hayes,
756 P.2d 298, 300 (Alaska 1988).
The AICPA has published a draft of a WORKING DRAFT-PRACTICE AIDVALUATION OF PRIVATELY HELD
C OMPANY E QUITY S E C UR IT IES I SSUED AS
COMPENSATION (2011).194 After discussion of the issues,
Section 9.06 of the Draft Practice Aid concludes:
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
divorce proceeding.
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
The Wisconsin Court of Appeals, in Arneson v. Arneson, 355 N.W.2d 16 (Wis. App. 1984), upheld the trial
courts application of a 25% combined minority and
marketability discount to a husbands one-third interest
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
in a family business.
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Id. at 18.
In Bernier v. Bernier, 873 N.E.2d 216, 228 (Mass.
2007), the Massachusetts Supreme Court held that the
trial court should not have applied the 35% tax rate of of
a C-corporation in estimating the fair market value of an
S corporation using the income approach, absent
evidence that the S-corporation would convert to Ccorporation status. In Sieger v. Sieger, 8 Misc.3d
1029(A), 806 N.Y.S.2d 448, 2005 WL 2031746, *18
(N.Y. Sup. 2005), the New York intermediate appellate
court rejected
a business valuators downward
adjustment of S-corporation income based on the
possibility that the current owner might switch to Ccorporation status or a potential buyer might not qualify
for S-corporation status, saying that [t]he court finds,
however, that the more appropriate valuation to be
placed on the facility is its value as currently operated
by defendant. Id. at *18, n. 19.
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
80
Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
Id. at 372.
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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19. Aswath Damodoran, APPLIED CORPORATE FINANCE: A USER'S MANUAL, ch. 12
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20. Strategic control adjustments would be used in establishing investment value but arguably not fair market value based on an unknown
hypothetical buyer.
21. Jesse A. Ultz , The Reasonableness of Owners' Compensation: An Often Overlooked But Key Assumption in Valuing a Business
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
24. Robert D. Arnott, Equity Risk Premium Myths p. 84 (Dec. 2011) <http://www.cfapubs.org/doi/pdf/10.2470/rf.v2011.n4.3> [3-27-2012].
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26. Lawrence A. Hamermesh & Michael L. Wachter, The Short and Puzzling Life of the "Implicit Minority Discount" in Delaware Appraisal
Law, 156 UNIV. OF PENNSYLVANIA LAW REVIEW 1 (2007)
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29. Harry Markowitz, Portfolio Selection, 7 The Journal of Finance 77 (1952) http://www.gacetafinanciera.com/TEORIARIESGO/MPS.pdf
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30. Frank J. Fabozzi, Francis Gupta, & Harry Markowitz, The Legacy of Modern Portfolio Theory, 11 The Journal of Investing 7, 7-8 (Fall
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32. <http://www.stanford.edu/~wfsharpe/art/djam/djam.htm> [2-27-2012].>.
33.
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f%20Risk.pdf> [2-27-2012].
34. Sharpe says that Economist Eugene Fama gave his theory the name of Capital Asset Pricing Model. See
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35. <http://www.nobelprize.org/nobel_prizes/economics/laureates/1990/press.html> [2-27-2012].
36. In modern finance articles and texts, the rate of return is often on the Y-axis.
37. Sharpe defended these two assumptions on the grounds that the proper test of a theory is not the realism of its assumptions but the
acceptability of its implications and a plea that criticism be tempered due to the dearth of alternative models. Id. at 434.
38. Sharpe credits Markowitz with showing how to create an efficient frontier, and James Tobins 1958 paper saying that, if you can borrow
or lend at the risk free rate to invest, then the efficient frontier is a single portfolio of risky securities with borrowing or lending as an option.
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41.
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42. See <http://www.standardandpoors.com/ratings/articles/en/us/?assetID=1245316529563> [2-22-12]. Perhaps U.S. Treasury securities
should be called the least risky alternative. See Robert S. Harris & Felicia C. Marston, The Market Risk Premium: Expectational Estimates
Using Analysts' Forecasts 11 JOURNAL OF APPLIED FINANCE 1, 4 n. 1 (2001)
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43. The "yield curve" is a graphical line that plots the yield (i.e., the interest rate divided by value of the bond), at different points in time, of
bonds having equal credit quality, but differing maturity dates. The most frequently-reported yield curve compares the 3-month, 2-year, 5-year
and 30-year U.S. Treasury debt. The slope of the yield curve can be measured as the difference between the interest rates at two selected
maturities. Long-term interest rates are influenced by expectations regarding future inflation. Thus, the shape of the yield reflects the market's
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
expectation of future interest rate changes.
44. William N. Goetzmann & Roger G. Ibbotson, History and the Equity Risk Premium p. 2 (Oct. 18, 2005) (Goetzmann)
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45. Goetzmann, p. 3.
46. Goetzmann, p. 9.
47. Goetzmann, p. 5. Fisher suggested that the safety of bonds is largely illusory since every bondholder runs the risk of a fall in the
purchasing power of money and this risk does not attach to the same degree to common stock, while the risks that do attach to them may be
reduced, or insured against, by diversification . . . . Goetzmann, p. 5.
48. Goetzmann, p. 6.
49. Goetzmann, p. 7.
50. Goetzmann, p. 18.
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57. The 2010 Duke CFO survey showed evidence of a strong positive correlation between market volatility and the long-term risk
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58. The 2010 Duke CFO Survey showed a highly significant correlation between the CFOs estimated ERP and the credit spread between
Moodys Baa rated bond yield less than 1-year T-bond yield. Graham-Harvey, The Equity Risk Premium in 2010 p. 13 (8-9-2010)
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
64. Duff & Phelps Client Alert (October 17, 2011)
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67. Duff & Phelps Client Alert (October 17, 2011)
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69.
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1_29_11.pdf> pp. 16-17[3-12-2012].
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72. Michael W. Barad, Technical Analysis of the Size Premium (undated)
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74. William N. Goetzmann & Roger G. Ibbotson, History and the Equity Risk Premium, p.10 (Oct. 18, 2005)
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79. Michael Barad and Tara McDowell, Capturing Industry Risk in a Buildup Model
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Business Valuation Upon Divorce: How Theory and Practice Can Lead to Problems In Court
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86. Roger J. Grabowski, Cost of Capital Estimation in the Current Distressed Environment, 4 JOURNAL OF APPLIED RESEARCH IN
ACCOUNTING AND FINANCE 31, 32 (2009)
<http://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID1436574_code438461.pdf?abstractid=1435131&mirid=2> [4-1-2012].
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88. Financial crises are often accompanied by a flight to quality. Investors are looking for places to park funds that they consider free
from [the risk of] loss of principal. They are not looking for yield. The nominal returns on risk-free securities fall dramatically for reasons
other than inflation expectations, and, thus, without adjustment, become less reliable as the best building block upon which to estimate the cost
of equity capital. The quotation, from Duff & Phelps Managing Director Roger Grabowski, is taken from Client Alert: Duff & Phelps
Increases U.S. Equity Risk Premium Estimate to 6% 7 (Oct. 17, 2011)
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90. In its October 17, 2011 Client Alert, Duff & Phelps said: In developing our ERP recommendation, we incorporate a normalized
20-year yield on U.S. government bonds of 4.0% (based on a trailing 12 month average) because, were we to use the spot yield-to-maturity of
2.66% as of September 30, 2011, we would arrive at an overall discount rate inappropriately low vis--vis the risks currently facing investors.
<http://www.duffandphelps.com/SiteCollectionDocuments/Articles/ERP_Update_10.17.11.pdf> p. 3 [3-10-2012].
91.
<http://www.duffandphelps.com/sitecollectiondocuments/articles/Article_Grabowski_Risk_Free_Rate_and_ERP_During_Flight_to_Quality_0
1_29_11.pdf> [3-12-2012].
92.
<http://www.duffandphelps.com/sitecollectiondocuments/articles/Article_Grabowski_Risk_Free_Rate_and_ERP_During_Flight_to_Quality_0
1_29_11.pdf> pp. 10-11[3-12-2012].
93. Duff & Phelps Decreases U.S. Equity Risk Premium Recommendation to 5.5%, Effective January 15, 2012 (Jan. 27, 2012)
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94. Current ERP at 5.5%, says new Duff & Phelps estimation (Jan. 25, 2012)
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95. <http://www.mencpa.com/news-46/post-62-thoughts-on-duff-phelps-normalizing-risk-free-rate.aspx> [3-23-2012].
96. <http://www.duffandphelps.com/SiteCollectionDocuments/Articles/ERP_Update_10.17.11.pdf> p. 3 [3-10-2012].
97. The horizon of the chosen Treasury security should match the horizon of whatever is being valued. Ibbotson SBBI Valuation
Yearbook (2011) p. 44.
98. Jeremy J. Siegel, Perspectives on the Equity Risk Premium, 61 FINANCIAL ANALYSIS JOURNAL 61, 62 (2005)
<http://info.freeman.tulane.edu/breese714/Investments%20Fall%202010/Perspectives%20on%20the%20Equity%20Risk%20Premium%20-%2
0Siegel.pdf> [3-27-2012].
99. Jeremy J. Siegel, The Shrinking Equity Premium <http://bbs.cenet.org.cn/uploadImages/20036131339163434.pdf> [3-22-2012].
100. Peng Chen, Will Bonds Outperform Stocks Over the Long Run? Not Likely, RETHINKING THE EQUITY RISK PREMIUM p. 127 (2011)
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101. On October 17, 2011, Duff & Phelps issued a client alert recommending that the U.S. Equity Risk Premium was 6.0% as of September
30, 2001. <http://www.duffandphelps.com/SiteCollectionDocuments/Articles/ERP_Update_10.17.11.pdf> [3-10-2012]. It dropped the U.S.
ERP to 5.5% as of January 15, 2012. <http://www.duffandphelps.com/SiteCollectionDocuments/Articles/ERP_Update_1%2031%2012.pdf>
[3-10-2012].
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103. Jeremy J. Siegel, Perspectives on the Equity Risk Premium, 61 FINANCIAL ANALYSIS JOURNAL 61, 65 (2005) (Siegal, Perspectives on
the Equity Risk Premium)
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0Siegel.pdf> [3-27-2012].
104. Rajnish Mehra, Rethinking the Equity Risk Premium (2011)
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109. Aswath Damodaran, Equity Risk Premiums (ERP): Determinants, Estimation and Implications The 2012 Edition (March 2012)
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110. The longer the data series, the more accurate the equity risk premium calculation, as long as the fundamental expectations have
remained the same. Goetzmann & Ibbotson, History and the Equity Risk Premium, HANDBOOK OF INVESTMENTS: EQUITY RISK PREMIUM p.
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111. Michael W. Barad, Ibbotson's Answer (undated)
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113.
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114. Goetzmann & Ibbotson, History and the Equity Risk Premium, HANDBOOK OF INVESTMENTS: EQUITY RISK PREMIUM p. 13
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115. Robert D. Arnott, Equity Risk Premium Myths, RETHINKING THE EQUITY RISK PREMIUM.
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119. Michael W. Barad, Ibbotson's Answer (undated)
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120. Duff & Phelps Client Alert (October 17, 2011)
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121.
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122. Duff & Phelps Client Alert (October 17, 2011)
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137. [B]ecause the stock market correction [in 2008-2009] has been heavily concentrated in the financial services sector and in highly
leveraged companies, the commonly-employed methods we use for estimating betas, the risk measure in the traditional CAPM, are potentially
flawed providing faulty estimates of risk. Roger J. Grabowski, Problems with Cost of Capital Estimation in the Current Evironment - Update,
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industry, outlook for the economy, etc. Id. p. 3. Fundamental analysis proceeds through the study of an investment by looking at the firm's (1)
competitive advantage, (2) earnings growth, (3) sales revenue growth, (4) market share, (6) financial reserves, and (6) quality of management,
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tends to move toward intrinsic value, the investment can be made so as to profit from the move of the price to intrinsic value. Fama (1965) p.
3. Burton Malkiel, in Chapter 7 of his book A RANDOM WALK DOWN WALL STREET (1973), points out that fundamental analysis cannot
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