Non-Systematic Risk Adjustments in Value and The Application of the Fair Market Value Standard in Business Valuation Practice
AbstractHistorically, courts have upheld, and business appraisers have applied, valuation adjustments for non-systematic risk, citing the fact that the typical real-world investor in closely-held company interests (of the subject asset type and risk class) is not able to own a well-diversified asset portfolio. Therefore, the Hypothetical Buyer, being defined as the typical real-world buyer, must also be assumed to be not well-diversified. In general, the courts and appraisers have been willing to overlook (or do not recognize) the implicit assumptions that underlie the generally-accepted definition of Fair Market Value. This paper presents a relevant and reliable challenge to the long-standing, generally-accepted appraisal practice of (1) interpreting the Fair Market Value Standard (FMVS) to characterize the Hypothetical Investors as not being well-diversified and (2) subsequently concluding they require an additional increment of discount for lack of marketability (DLOM) for a given subject closely-held company’s non-systematic risk. The characterization of the Hypothetical Investor as the typical real-world investor is accepted (at least as a starting point), as well as the FMVS’s generallyaccepted assumptions that the Hypothetical Investor is simultaneously rational, well-informed, and financially able to purchase the subject interest (among its other assumptions). It develops an internally consistent conclusion from the logical implications of these assumptions; the Hypothetical Investors are welldiversified. Being well-diversified, they do not require a valuation discount for non-systematic risk-affected individual assets that are included in their asset portfolios, since that risk is largely diversified away.
Download InfoIf you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
Bibliographic InfoPaper provided by University of Connecticut, Department of Economics in its series Alumni working papers with number 2013-04.
Length: 38 pages
Date of creation: May 2013
Date of revision: Jul 2013
Contact details of provider:
Postal: University of Connecticut 341 Mansfield Road, Unit 1063 Storrs, CT 06269-1063
Phone: (860) 486-4889
Fax: (860) 486-4463
Web page: http://www.econ.uconn.edu/
More information through EDIRC
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; welldiversified; hypothetical investor; hypothetical buyer; hypothetical seller; hypothetical market construct; hypothetical transaction; bonbright;
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
- 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, vol. 19(3), pages 425-442, 09.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Kasey Kniffin).
If references are entirely missing, you can add them using this form.