The Persistence of Rules of Thumb

Abstract

Abstract In this article I explore the reasons why, despite the supposed theoretical superiority of income methodologies, rules of thumb are often utilized to determine the equity value in Main Street exchanges. The examples of Main Street equity sales I cite are from the purchase and sale of small accounting practices in which I was party to the exchange. Based on an analysis of these exchanges, I conclude that the reason why rules of thumb were used in lieu of income methodologies was not primarily due to the comparative simplicity of the former over the latter. Rather I demonstrate that income methodologies failed to capture the underlying economics of the transfer. Furthermore I argue that while rules of thumb did not provide a precise guide to determining a rational price, this method provided a rational enough criterion to determine an equity price. Finally, citing the work of Kahneman, Knetsch, and Thaler on reference transactions I demonstrate how rules of thumb can come to represent what counts a...