Valuation Practitioners Research Articles

Pass-through Entities: A Tax Equivalent Method to Adjust the Cost of Equity

A contentious debate continues between the IRS, tax courts, and valuation professionals regarding the valuation of pass-through entities. Considerable diversity of practice has risen around the taxation treatment and benefit determination of pass-through entities when using cost-of-capital estimates derived from public equity markets. Lacking direct evidence of the cost-of-equity capital in a privately held entity, valuation practitioners often turn to the public equity markets for a cost-of-equity measure to use when applying income-based valuation methods. Over the years, valuation practitioners have adopted various pass-through entity adjustment models to reconcile the value of pass-through entities relative to public companies. However, many of the pass-through models currently in use do not consider all of the tax burdens that may be included in the publicly derived equity risk premium. Following others, we review support for the notion that using public stock market returns to derive a cost-of-equit...

Capturing the complexity of biodiversity: A critical review of economic valuation studies of biological diversity

Biodiversity is a highly complex and abstract ecological concept. Even though it is not one physical entity, it influences human well-being in multiple ways, mostly indirectly. While considerable research effort has been spent on the economic valuation of biodiversity, it remains to be a particularly challenging ‘valuation object’. Valuation practitioners therefore have to use proxies for biodiversity, many of which are very simple (single species, habitats). This paper presents a comprehensive and critical review of biodiversity valuation studies with special emphasis on biodiversity valuation in order to depict the state-of-the-art in this research field. It develops evaluation criteria so as to identify best-practice applications and shows that the field of biodiversity valuation studies is rather heterogeneous regarding both valuation objects and valuation methods. On the basis of our evaluation criteria and best-practice studies we suggest that to account for the complexity and abstractness of biodiversity, multi-attribute approaches with encompassing information provision should be used that emphasise the roles biodiversity plays for human well-being.

Use of coastal economic valuation in decision making in the Caribbean: Enabling conditions and lessons learned

Caribbean economies depend on coastal ecosystem services, including tourism, fisheries, and shoreline protection. However, coastal ecosystems continue to degrade due to human pressures. Many pressures arise from decisions that fail to take full range of ecosystem values and benefits into account.Economic valuation can contribute to better-informed decision making about coastal resource use and development. More than 100 studies in the Caribbean contain monetary values of coastal ecosystem goods and services. However, only a minority of these studies have had an observable influence on policy, management, or investment decisions. Through a series of interviews, we identified 17 valuation studies that have directly influenced decision making. Due to the difficulty of tracking influence, our review was not exhaustive.These 17 “success stories” highlight the potential for economic valuation to improve decision making. Building on literature on the challenges of integrating science into policy, we used these 17 cases to identify enabling conditions for informing decision making. These conditions include a clear policy question, strategic choice of study area, strong stakeholder engagement, effective communications, access to decision makers, and transparency in reporting results.Our findings suggest that valuation practitioners can and should do more to ensure that valuation studies inform decision making.

A new approach to private firm fair value valuation in line with IFRS 13 – the concept of the most advantageous market discount (MAMD)

IFRS 13, adopted in 2013, introduced a general framework for fair value valuation of unquoted equity instruments. It has to be performed in line with the “highest and best use” concept and in the conditions of potential transactions carried out on “the most advantageous market”. This article presents a new and comprehensive approach to the valuation process of such instruments, which meets these IFRS 13 requirements. This approach applies a concept of the most advantageous market discount (MAMD), based on the well-known underpricing phenomenon. The application of this discount along with the Markowitz theory results in a cohesive, comprehensive and practical framework for unquoted equity instruments valuation according to the fair value concept compliant with IFRS 13. Additionally, this paper presents estimations of MAMD for the UK, Germany, France, Switzerland, and Poland. The obtained results can help valuation practitioners apply the MAMD concept in the process of unquoted equity instruments valuation according to IFRS 13. Compared to other approaches which address the issue of private company valuation, the presented valuation framework for the first time reconciles the requirements set in IFRS 13 fair value definition with the assumption of valuation in the reality of imperfect markets.

The Default Spread Model: A Practical Method for Measuring Conditional Equity Risk Premium

Until the financial crisis of 2008, most valuation practitioners tended to use a static equity risk premium usually based on historical data. The crisis of 2008 brought with it a “flight to safety” phenomenon, which resulted in record low risk-free rates. Consequently, valuation practitioners faced the odd situation of a declining cost of equity in the context of a significantly higher risk economic environment. To resolve this dilemma, practitioners have started to accept the notion that the equity risk premium (ERP) changes over time. This notion is well supported by academic research, which shows a strong relationship between the ERP and economic cycles. However, as valuators, we still lack consistency in the measurement of a conditional ERP. As a group, we are in need of a practical, reliable, and objective method that would enable us to measure changes in ERP in a somewhat consistent manner. This article attempts to do so by presenting a method to measure the conditional ERP that is simple, objective, and, when tested historically, provides reasonable results. Our method is premised on the well-accepted theory that changes in default spreads correspond to changes in ERP.

Evidence‐Based Management and Academic Research Relevance

This study seeks to understand how academic business valuation research influences business practice. It uses knowledge market theory to assess the efficacy of the evidence‐based solution to academic research relevance. Fifteen semi‐structured interviews were conducted with chartered business valuators in Canada. Interview transcripts were subjected to thematic analysis using QSR's NVivo software (QSR International, Cambridge, USA). The research findings revealed that academic research on business valuation is relevant to business valuation practitioners. The professional nature of the business valuation profession promotes evidence‐based management practices and encourages the use of academic literature in managerial decision making. Business valuation academics should not change the manner in which they publish scholarly articles. Instead, a solution to the academic relevanceproblem resides in having efficient market intermediaries in the form of knowledge translation mechanisms. Copyright © 2012 John Wiley & Sons, Ltd.

Integrating Ecology and Economics for Restoration: Using Ecological Indicators in Valuation of Ecosystem Services

Because it can uniquely furnish insights into nonuse values for ecosystem services, survey‐based Stated Preference (SP) valuation is widely used to estimate the benefits of ecological restoration. SP surveys ask respondents to select among restoration options yielding different ecological outcomes. This review examines the representation of ecological outcomes in SP studies seeking to quantify values for restoration of aquatic ecosystems. To promote the validity of ecological indicators used in SP valuation, we identified four standards: indicators should be measurable, interpretable, applicable, and comprehensive. We reviewed recent SP studies estimating the value of aquatic ecosystem services to assess whether ecological indicators in current use had these desirable properties. More than half of the 54 indicators reviewed were measurable, meaning referable to potentially precise quantification. About one‐third were interpretable, that is, presented in a way that facilitates understanding the effects of restoration. About three quarters of the indicators were applicable; SP valuation practitioners typically consult with natural scientists to ensure that indicators represent the effect of stressors on ecological systems and with focus groups to ensure that indicators have a connection with ecosystem services that contribute to public well‐being. While most of the SP studies employed diverse and potentially comprehensive indicators that could capture direct and indirect effects of restoration, and 6 of 20 studies used indicators that met all standards, shortcomings in the indicators were common. These problems can be rectified with attention to how natural scientists measure change and to relationships between restoration outcomes and characteristics of fully restored reference ecosystems.

Stand Up and Shout—It Is Another DLOM Put Model!

Abstract European style fixed strike, lookback, and asian put option models have been proposed and utilized by business valuation practitioners to estimate discounts for lack of marketability. Another form of put option, a shout put or shout floor option, more closely mimics marketability than do the previously mentioned forms of put option because both marketability and a shout put option give a stockholder the right to lock in a selling price (the prevailing marketable stock price) for the stock at any point in time over the term of the option. By comparison, over the term of the option the European fixed strike put gives the stockholder the right to lock in a selling price equal to the current stock price; the lookback put gives the stockholder the right to lock in a selling price equal to the highest stock price achieved; and the asian put gives the stockholder the right to lock in a selling price equal to the average of all stock prices achieved. Because the shout put option more closely mimics marke...

Valuing scenic amenity using life satisfaction data

The life satisfaction approach has recently emerged as a new technique in the suite of options available to non-market valuation practitioners. Employing data from the Household, Income and Labour Dynamics in Australia (HILDA) survey and Geographic Information Systems (GIS), this paper examines the influence of scenic amenity on the life satisfaction of residents of South East Queensland (SEQ), Australia. Measuring scenic amenity on a 10-point scale, it is found that, on average, a respondent is willing-to-pay approximately AUD$14,000 in household income per annum to obtain a one-unit improvement in scenic amenity. However, on closer inspection, we find that the relationship between willingness-to-pay and the level of scenic amenity is not linear. To our knowledge, this is the first paper to value scenic amenity using the life satisfaction approach and is the first paper to use this approach to value any type of environmental good or service in SEQ. As such, this paper represents a genuine contribution to a small, yet growing, body of literature.

Sustainability and property valuation

PurposeThe aims of this paper are to: provide a systematic overview of various publications and international research efforts undertaken to integrate sustainability considerations into the property valuation process; summarize the key results of these publications and research efforts; highlight the role of key valuation‐input variables in considering sustainability issues when applying traditional methods of valuing income‐producing properties; briefly present and comment on a broader concept of property value and the resulting implications for property valuation practice; and provide recommendations for change in the everyday practice of individual valuation professionals and for the future operation of professional organisations and valuation‐standard‐setting bodies.Design/methodology/approachThis paper builds on the authors' previous contributions to the discussion on sustainability and valuation, presents advances on these previous works and condenses the more theoretical issues debated earlier into concrete recommendations for future action. Starting from a literature review of the different strands of research relating to the new discipline of sustainable property investment, 31 publications and ten research projects that investigate in detail the topic of sustainability and property valuation are identified and the current stage of discussion is briefly commented on. On this basis, a systematisation of existing approaches for the integration of sustainability issues into the valuation process is presented, followed by further explanations of practical valuation issues such as identifying the key “adjustment screws” or valuation input parameters of traditional valuation methods. Finally, the underlying concept of property value is discussed and a “value map” is presented which conceptualises the relationships between different components of value as well as other value‐influencing forces.FindingsChanges are required in the processes of gathering, processing and presenting property‐related information, as well as in the methods for determining individual valuation‐input parameters and for explicitly stating formerly implicit assumptions and qualitative judgement. This includes but is not limited to the extension of the scope and informational content of standard valuation reports to include sensitivity analyses, risk documentation and a separate section on sustainability. The required changes should be supported by actions that could be undertaken by the professional and valuation‐standard‐setting bodies and organisations within the valuation world. These actions include: embracing and improved marketing of the qualitative nature of the valuation service; the development of educational material and formal guidelines; the provision of dedicated market research to assist valuation practitioners operating in different market segments, geographic regions and local sub‐markets; and adjusting and further developing existing valuation standards to enable and support individual practitioners in offering a two‐tier valuation service to clients.Originality/valueThis paper proposes that valuation professionals and their professional bodies are confronted with a new reality of changing value perceptions and systems among market participants, and offers practical recommendations on how to cope with this situation.

Rebate rules in threshold public good provision

This paper considers how six alternative rebate rules affect voluntary contributions in a threshold public-good experiment. The rules differ by (1) whether an individual can receive a proportional rebate of excess contributions, a winner-takes-all of any excess contributions, or a full rebate of one's contribution in the event the public good is provided and excess contributions exist, and (2) whether the probability of receiving a rebate is proportional to an individual's contribution relative to total contributions or is a simple uniform probability distribution set by the number of contributors. The paper adds to the existing experimental economics literature on threshold public goods by investigating both aggregate and individual demand revelation under the winner-take-all and random full-rebate rules. Half of the rules (proportional rebate, winner-take-all with uniform probability among all group members, and random full-rebate with uniform probability) provide total contributions that nearly equal total benefits, while the rest (winner-take-all with proportional probability, winner-take-all with uniform probability among contributors only, and random full-rebate with proportional probability) exceed benefits by over 30%. Only the proportional rebate rule is found to achieve both aggregate and individual demand revelation. Our experimental results have implications for both fundraisers and valuation practitioners.

Life and Death of Businesses: A Review of Research on Firm Mortality

Neither the literature of finance nor the literature of valuation practitioners has taken account of the relatively short life expectancy of firms. Fewer than fifty percent of new firms live longer than ten years; yet, it is common practice to estimate firm value with a very long term horizon model such as the constant growth model. The purpose of this paper is to increase awareness of the life expectancy of firms and show how to take account of the likelihood of firm death in valuation. Data on firm death rates and life expectancy that is available in the field of industrial organization is reviewed and summarized so that valuation practitioners can take it into account in their valuations.

Minimum Marketability Discounts, 3rd Edition

Abstract The objective of this study of LEAPS is to contribute to improved substantiation of the discount for lack of liquidity, long a concern of both valuation practitioners and courts. The study...

Fairness in the contingent valuation of environmental public goods: attitude toward paying for environmental improvements at two levels of scope

Respondents to contingent valuation (CV) surveys give a variety of reasons for not wanting to pay money. This variability is likely to reflect people's attitudes toward paying for the public good change, their attitudes toward paying for public goods in general, and a component that is independent of these attitudes but unique to particular beliefs about paying (e.g. ‘I can't afford to pay’). Negative attitudes toward paying can contribute to an apparent insensitivity to different levels of the same public good. In a telephone survey, northern Wisconsin property owners were asked about their WTP for four environmental public goods (biodiversity, Indian spearfishing, water quality, and wolves) at two levels of scope (part and whole). For water quality and spearfishing, the part was a chain of lakes that was geographically nested within a larger region of lakes. Similarly, the biodiversity whole represented a region comprising the smaller level of the public good. The scope conditions for wolves were quantitatively nested levels of returning 300 and 800 wolves to northern Wisconsin. Respondents’ beliefs about paying for each public good and level of scope were measured in order to test their generality across the different public goods and levels of scope. Negative attitudes toward paying that are general across public goods place restrictions on the use of CV for environmental public goods. However, negative attitudes that are tied to specific environmental public goods suggest that the valuation method might be difficult to implement in these cases only. Moreover, negative attitudes toward paying that are either general or specific may contribute to perfect embedding when they are expressed across different levels of scope for the same public good. Respondents' beliefs about paying for each public good were associated with an attitude toward paying for the respective good and an attitude toward paying for public goods in general at both levels of scope. The general attitude was more explanatory of beliefs about paying for wolf reintroduction and spearfishing than were the specific attitudes. The distribution of beliefs was sensitive to the type of good being valued, but less so to the scope of the public good change. Contingent valuation practitioners should seek improvements in respondents' perceptions of the fairness of the valuation process in order to facilitate citizens' involvement in decisions about environmental public goods. Avenues for future research are proposed and discussed.

Identifying ecosystem services using multiple methods: Lessons from the mangrove wetlands of Yucatan, Mexico

The failure to properly account forthe total value of environmental and natural resourcesresults in socially undesirable overexploitation anddegradation of complex ecosystems such as mangrovewetlands. However, most ecosystem valuation researchtoo often focuses on the question of “what is the value” and not enough on “what peoplevalue.” Nonmarket valuation practitioners have usedqualitative approaches in their work for some time.Yet, the relative strengths and weaknesses ofdifferent qualitative methods have been more thesubject of speculation than systematic research. Thestatistical examination of focus group and individualinterview data on ecosystem services illustrates thatthe two methods generate important but differentecosystem service data. Further, the data show thatthe use of multiple data collection methods offers amore robust understanding of what people value.