Valuation Adjustments for Non-Systematic Risk in Business Valuation Practice Under the Fair Market Value Standard
AbstractHistorically, appraisers have applied and courts have upheld valuation adjustments for non-systematic risk, citing the typical real-world investor in closely-held company interests is not financially able to diversify well. The Hypothetical Buyer, being defined as the typical real-world buyer, also is assumed to be not well-diversified. Appraisers and courts have exhibited a willingness to overlook (or don’t recognize, acknowledge) the implicit assumptions underlying the generally-accepted definition of Fair Market Value. We present a relevant and reliable challenge to the long-standing appraisal practice of (1) interpreting the Fair Market Value Standard (FMVS) to characterize Hypothetical Investors as not well-diversified and (2) subsequently concluding they require an additional increment of “required rate of return” in the form of a discount for lack of marketability (DLOM) for a subject closely-held company’s non-systematic risk. We accept the characterization of the Hypothetical Investor as the typical real-world investor as a starting point, and the FMVS’s given assumptions. We develop an internally consistent conclusion from the straightforward logical implications of these assumptions; Hypothetical Investors are well-diversified. They don’t require a valuation adjustment for non-systematic risk because it is largely diversified away.
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Bibliographic InfoPaper provided by University of Connecticut, Department of Economics in its series Alumni working papers with number 2013-04.
Length: 51 pages
Date of creation: May 2013
Date of revision: Dec 2013
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business valuation; non-systematic risk; unsystematic risk; diversifiable risk; unique risk; fair market value standard; fmvs; willing buyer-willing seller standard; diversification; rational; well-informed; financially able; well-diversified; hypothetical investor; hypothetical buyer; hypothetical seller; hypothetical market construct; hypothetical transaction; bonbright; CAPM; required rate of return; dlom; discount for lack of marketability;
Find related papers by JEL classification:
- D01 - Microeconomics - - General - - - Microeconomic Behavior: Underlying Principles
- D40 - Microeconomics - - Market Structure and Pricing - - - General
- D46 - Microeconomics - - Market Structure and Pricing - - - Value Theory
- G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
- K00 - Law and Economics - - General - - - General (including Data Sources and Description)
This paper has been announced in the following NEP Reports:
- NEP-ALL-2013-06-04 (All new papers)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, American Finance Association, vol. 19(3), pages 425-442, 09.
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