Abstract The value of a closely held company may represent a significant component of a marital estate. Business valuation services play an increasingly crucial role in determining the value of a closely held family business and often facilitate a divorce settlement by providing an appraisal estimate in the absence of an actual sale as a basis to distributing marital assets. The results of the current study investigate family courts' decisions in cases where the marital estate includes a closely held company. In each case a valuation expert was retained by both spouses. The favorable decision was the verdict that selected either the husband's or wife's expert. The decisions were influenced by two factors: state law (community property versus equitable distribution) and the owner of the business (the husband alone or either the wife alone or as coowner). Cases in equitable distribution states had an odds ratio that was four times higher for a decision for the wife than cases in community property states, and cases in which the wife was either the sole owner or co-owner of the business had an odds ratio that was over four times higher to render a decision for the wife.
The value of a closely held company may represent a significant component of a marital estate. Business valuation services play an increasingly crucial role in determining the value of a closely held family business and often facilitate a divorce settlement by providing an appraisal estimate in the absence of an actual sale as a basis to distributing marital assets. Valuation in the construct of divorce has some unique intrinsic characteristics that differ from a transaction between a willing buyer and willing seller. State law defines which marital property is subject to valuation and distribution, regardless if the property can be sold to a willing buyer. The valuation's purpose is to determine the value to the current owner in the marital community (Aalberts, Clauretie and Matoney 2000; Zipp 1992; Cenker and Monastra 1991; Evans 1994; Zipp 1992).
Business valuation in a matrimonial action presents itself with an array of issues that contribute to the complexity of an already difficult process. This study investigates whether specific characteristics of gender, state law and the nature of business ownership may influence the manner in which the value of a closely held company is ultimately awarded by the court.
Prior studies on the courts' valuation focused on specific valuation methods presented to the court and accepted in valuation cases (Martin 1972). Brody and Berger (1977) analyzed weighted average valuations presented to the court. Additional studies from Boseland (1963), Englebrecht and Davidson (1977) and Englebrecht (1979) examined the court ruling in the middle of the two experts' valuations. Boatsman and Baskin (1980) tested tax court valuation procedures that were accepted by the court. LeClair (1990) focused on prediction accuracy of earnings methods. Beatty Riffe and Thompson (1999) analyzed market comparables in valuing closely held companies in the tax court. DiGabriele (2007) investigated preferences for specific valuation methods in the matrimonial court and found that matrimonial courts were more likely to prefer the capitalization of earnings method when inflation was high, and involved a manufacturing company. In addition, the matrimonial court was more likely to prefer the excess earnings method when the case did not involve a service company.
Additional studies on divorce's effect on the family business have illustrated that closely held companies are a primary or sole source of marital funds (Rowe and Hong 2000). Galbraith (2003) concluded that divorce affects short-term financial performance of a family owned closely held company.
This research makes several incremental contributions to the literature on the court's valuation of closely held companies. Astrachan and Shanker (2003) estimate that closely held companies represent 89% of business tax returns filed with the Internal Revenue Service, employ 62% of the workforce and contribute 64% to the gross domestic product of the United States.
Considering this contribution, the valuation of closely held companies may be one of the most important issues in financial disciplines such as accounting, corporate finance and economics.
Finally, the results of this research can also be of significant concern to practitioners including accountants, economists, finance professionals, investment bankers, lawyers and expert witnesses.
II. Motivation for Study
Statistically speaking, modern marriages have the likelihood to fail fifty percent of the time (Galbraith 2003, Braver and O'Connel 1998). The economic impact of divorce on the family unit has been acknowledged in prior research. However, there has been a dearth of research on the dynamics of asset distribution in a marital estate when a closely held business is part of the holdings (Galbraith 2003, Braver and O'Connel 1998, Higgins, Duxbury and Lee 1994, Evans 1994). The controversy and dynamics can be easily illustrated in the case of Scheppelmann (2007). The trial court originally found that Scheppelmann Electric was worth between $220,000 and $320,000. As a result of the trial court's finding, the wife appealed the decision. The Michigan Court of Appeals found that the valuation range previously determined by the trial court was not misleading because the expert provided a range of values for the subject company. On remand, the trial court valued the business at $220,000 and found that $20,000 of that amount represented the defendant's separate property as the value of the business when he received it from his father in 1976. The court divided the remaining portion on a 60/40 basis in favor of the defendant. The wife was awarded $80,000 as her share of this business asset. The court partitioned the premarital component of the closely held company, affirming the persuasive feature state law may play in the ultimate award in a matrimonial dissolution. In the previous case illustration, the issue of the asset award centered on the concept of equitable distribution as the basis for distributing marital property. Equitable distribution is the division of marital assets that focuses on contribution and need when determining how assets are to be divided (Aalberts, Clauretie and Matoney 2000; Baker 1998). Equitable distribution allows for a much more flexible framework in marital asset divisions making it inherently difficult to predict an outcome. Some courts have used extensive discretion in dividing marital assets in an equitable distribution jurisdiction. Matrimonial courts in some equitable distribution states have based "their decisions on factors such as length of marriage, emotional support, spouses' ages and employability" (Baker 1998). Conversely, the concept of a "marital partnership," is recognized in community property states such as, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. The objective of this concept is that assets earned during marriage are considered joint assets of the "marital partnership" and are usually divided evenly.
The community property concept is distinctly different from the latitude available in equitable distribution, which is probably why matrimonial courts have been asked whether gender considerations contributed to their methods of valuing the contributions of a non-working spouse (Baker 1998). To add to this controversy, some equitable distribution states utilized an unwritten rule that ignored marital contributions in high net worth divorces, which resembled "enough is enough" for non-working spouses (Wendt v. Wendt 1997). However, in a landmark decision (Wendt v. Wendt) in the equitable distribution state of Connecticut, the judge ruled, "there is no limitation as to the amount of alimony, periodic alimony or division of property that can be awarded to a person who is the non-monetary contributor in a long-term high-asset marriage." Considering the previous motivating literature and the flexible statute of equitable distribution that gives the court more discretion to apportion assets to the party they believe may be economically disadvantaged, it is hypothesized that: matrimonial court decisions in equitable distribution states are more likely to favor the wife in marital estates that include a closely held company.
Recent empirical evidence has indicated that both spouses request and actively take part in the family owned closely held business creating a cooperative arrangement between the family and the business (Galbraith 2003, Poza and Messer 2001). Danes and Olsen (2003) investigated 391 family business-owning couples to examine the work involvement of the wife in the business. Fifty seven percent of wives worked in the business, forty seven percent of whom were paid. Forty two percent of wives were considered major decision makers. Considering that the contemporary household may include both spouses who are working it appears likely that when a family business is a component of the marital estate, the husband and wife may share management and ownership. For professional firms such as those used by medical doctors, attorneys and accountants, formal ownership is not option for an unlicensed spouse even though they may work in the firm. There are additional ownership issues resembling active and passive ownership. Active participation in a business generally means that the participant engages in activities making major management decisions, and other efforts intended to enhance the value of the business. Passive ownership in a matrimonial case is referred to as a situation whereby a spouse who may have had direct or indirect possession of a business interest but made no attempt to enhance the value. The motivation for the spouse who is exclusively operating the business is obviously to preserve as much value as possible. With the contemporary American households moving away from gender role specialization, both spouses share in the "market provision for the household" with men usually earning more than females (Oppenheimer 1997). This disparity provides a financial advantage, moving towards the spouse with greater financial resources. In order to bridge this lack of equality, men are usually court ordered to pay support payments to the financially weaker spouse (Oppenheimer 1997). As a matrimonial action plays out in the court system, considerations such as the financial inequality between spouses may indeed influence the ultimate decision of which party that ends up with the marital estate's potentially most valuable asset, the business. A decision for former spouses to coexist in a post divorce business setting is really not a workable option (Galbraith 2003).
Equitable ownership of businesses has been a source of controversy in the family courts. In general, when the family unit shares the profits from the business entity joint ownership is implied as part of the marital partnership. The implied partnership is accordingly recognized under the law of partnerships. Sharing of profits is sufficient to represent the intent of the parties for an implied partnership to exist. Progressive divorce cases have, on occasion, accepted this line of logic (Turner 2003). Thus it is hypothesized that: matrimonial decisions favor the wife when she is considered an owner or part owner of the family closely held company.
In summary, matrimonial law has traditionally relied on judicial wisdom to achieve fair division of marital assets. Law makers have typically given matrimonial judges complete discretion, which is enhanced by the infrequency of jury trials. In fact, for most divorce actions the judge determines both the facts and interprets the law. During the past two decades, judicial discretion in divorce cases has been expanded, allowing title based property division to be succeeded by discretionary distribution philosophy (Garrison 1996).
III. Methodology and Research Design
The primary source of data for this study was extracted from a database maintained by Business Valuation Resources, LLC. This database contains information on business valuation court cases at the federal and state levels. The data for the study are observed during the sample period of January 1996 through December 2007. The data was extracted from the Legal and Court Case Update section of the publication Business Valuation Update. This section provides summaries of cases that are focused on valuation for tax litigation, shareholder disputes, and matrimonial matters; the cases involving matrimonial actions were segregated. In addition, each selected case was cross referenced through the Lexis-Nexis database to verify the identity of the plaintiff and defendant.
Several variables are extracted from each court case in order to address the two hypotheses. The dichotomous dependent variable was based on who the decision was in favor of, the husband or wife (gender, coded 0 for husband and 1 for wife). In each case a valuation expert was retained by both spouses. The favorable decision was the verdict that selected either the husband or wife's expert. This variable is motivated by the considerable discretion available to matrimonial judges (Garrison 1996), and the subjectivity of equitable distribution (Baker 1998). There were seven independent variables that were extracted. State law was considered because of the inherent differences between the community property and equitable distribution. This variable was operationalized as a dummy variable with community property as the reference category. Theory also suggests the gender of the plaintiff who initiates the case may have an effect on the outcome. As a result a dummy variable for the gender of the plaintiff was created with the base group being men and coded as 0 with women coded as 1. A dummy variable for the owner of the family business was also included in the model with the base group being men coded as 0. This variable is motivated by judicial discretion in title based property division in equitable distribution (Garrison 1996). Since judges are not financial experts, theory suggests that the valuation approach used in the case may impact a judicial opinion due to court familiarity. Two variables were created for the valuation approached used. The income approach was coded as 0 if it is not used in the case and 1 if used. The asset approach was coded in the same manner. The market valuation approach is the base category.
In addition, two control variables were included in the model, the annual inflation rate and the specific state individual per capita income. It is expected that the coefficient would be negative for the per capita income variable. This is based on the consideration that a husband may more likely be financially established prior to entering into a marriage in high income states. Prior research has indicated that price stability has the potential to reduce divorce rates (Nunley 2007). Therefore, annual inflation (at the time of the decision) was included in the model as a control variable. However, it is expected that as inflation rises the uncertainty associated with price instability may influence the court to side with the wife to compensate for any potential economic disparities. The final model can be reflected in the following equation:
(1) Logit (Husband/Wife) = á + â1(Per Capita Income) + â2 (Annual Inflation) + â3 (StateLaw) + â4 (Plaintiff's Gender) + â5 (Business Owner's Gender) + â6 (Income Valuation Approach) + â7 (Asset Valuation Approach)
A. Descriptive Statistics
A total of 125 cases were available for analysis. Overall, 42 of the 125 decisions (33.6%) were for the husband, while 83 (66.4%) were for the wife. Table 1 contains descriptive statistics for the variables included in the study overall and as a function of the court's decision. State law was defined as either community property (0) or equitable distribution (1). Overall, 29.6% of the cases came from community property states, but this consisted of 47.6% of the cases in which the decision was for the husband and 20.5% of the cases for which the decision was for the wife. The wife was the plaintiff 64.0% of the time, including 59.5% of the cases in which the decision was for the husband, and 66.3% of the time when the decision was for the wife. The asset valuation approach was the most frequently used method (46.4% of cases). Given the low frequencies of wife-owned business (n = 7), the owner of the business variable was dichotomized into cases where the husband owned the business (coded as 0) and cases in which either the wife owned the business or both the husband and wife owned the business (coded as 1). In nearly three-quarters of the cases (73.6%), the owner of the business was the husband alone. In cases where the decision was for the husband, the husband alone owned the business 85.7% of the time compared to 67.5% of the time when the wife was the owner or coowner of the business. The mean per capita income was $29,952.09 (SD = 4751.82), while the annual inflation rate was .03 (SD = .01).
B. Bivariate Analyses
The initial step in the examination of the relationships between the court's decision and the control and predictor variables was a set of bivariate analyses. For the categorical predictors, ÷2 tests of independence were performed while t tests were performed for the continuous control variables. The first test compared the court's decision for community property states and equitable distribution states. The ÷2 test was statistically significant, ÷2 (1) = 9.86, p = .002. Percentages for cases within community property states indicated that the court's decision was for the wife 45.9% of the time, while in equitable distribution states the decision was for the wife 75.0% of the time.
The next test compared the court's decision based on the plaintiff's gender in the case. The ÷2 test was not statistically significant, ÷2 (1) = .55, p = .458. The percentage of cases where the husband was the plaintiff in which the decision was for the wife (62.2%) was similar to the percentage of cases where the wife was the plaintiff and the decision was for the wife (68.8%). The third test compared the court's decision as a function of the valuation approach selected. This test was not statistically significant, ÷2 (2) = .42, p = .812. The percentage of cases in which the decision was for the wife was similar regardless of whether the asset (65.5%), income (69.6%) or market (61.9%) approaches were used. The final ÷2 test compared the court's decision as a function of the gender of the owner of the business. This variable is statistically significant, ÷2 (1) = 4.78, p = .029. The percentage of cases where the husband was the sole owner and the court's decision was for the wife (60.9%) was lower than the percentage of cases where the wife was the owner or co-owner and the decision was for the wife (81.8%).
Two independent sample t tests were then conducted comparing cases in which the decision was for the husband and the decision was for the wife in terms of per capita income and annual inflation rate. The comparison of per capita income as not statistically significant, t (123) = .46, p = .648. This indicates that the per capita income in cases where the decision was for the husband (M = 30226.10, SD = 5144.94) was similar to the per capita income in cases where the decision was for the wife (M = 29813.42, SD = 4566.39). The test comparing the annual inflation rates was also not statistically significant, t (123) = -1.32, p = .190, indicating that the annual inflation rate in cases where the decision was for the husband (M = .03, SD = .01) did not differ from the annual inflation rate in cases where the decision was for the wife (M = .03, SD = .01).
C. Logistic Regression
Table 2 shows the results of the logistic regression analysis performed to determine which of these variables were predictive of the court's decision. The baseline model correctly classified 66.4% of the cases based upon a predicted probability outcome of greater than 50%. In the first block of the analysis, the two control variables (per capita income and annual inflation) were entered. This model was not statistically significant, ÷2 (2) = 2.25, p = .324. In the second block the five predictor variables were entered and the logistic regression model was statistically significant, ÷2 (7) = 19.66, p = .006, with 71.2% of cases correctly classified. This shows a 4.68% increase in the predictability of the court's decisions based on the Block 2 regression model.
Three of the predictor variables were statistically significant. First, the state law was a statistically significant predictor of the court's decision, Wald (1) = 9.10, p = .003. The odds ratio for state law was 4.14, and given the coding of this predictor (i.e. 0 = community property, 1 = equitable distribution), this indicates that cases in equitable distribution cases had an odds ratio of 4.14 times to result in a decision for the wife than cases in community property states. The second statistically significant predictor was the gender of the owner of the business, Wald (1) = 6.72, p = .010. The odds ratio for the business owner was 4.30. In this case, the coding of the predictor (i.e. 0 = husband alone, 1 = wife alone or both husband and wife) indicates that in cases where the wife was either the sole owner or co-owner of the business, the court had an odds ratio of 4.30 to render a decision for the wife. The plaintiff's gender in the case, the valuation approach, and per capita income, were not statistically significant as predictors of the court's decision. The control variable annual inflation was statistically significant at p<.10. The marginal effect shows that a one percentage point increase in inflation (e.g. from 2% to 3%) causes the probability of the wife winning to increase by 0.15. The probability density function was analyzed at the means of the independent variables as described in Greene (2003).
In summary, the court's decision was for the wife in 66.4% of the 125 cases examined. The court's decision was influenced by two factors: state law (community property versus equitable distribution) and the owner of the business (the husband alone or either the wife alone or as co-owner). Cases in equitable distribution states had an odds ratio over four resulting in a decision for the wife than cases in community property states, and cases in which the wife was either the sole owner or co-owner of the business, the odds ratio was also over four times to render a decision for the wife. None of the other potential predictors examined except annual inflation (the plaintiff in the case, the valuation approach, and per capita income) were related to the court's decision.
An implication of the results of the current study was that the court may indeed be influenced by equitable distribution and community property considerations. Although there is a high degree of variability in each case, the current study provides some empirical basis for making decisions in these types of environments. A second implication of the current study is related to ownership of the business. This study provides particular empirical basis for business ownership in a matrimonial setting in different legal regimes. A limitation in the study is the data did not indicate if premarital or post marital agreements influenced the division of marital assets.
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* DiGabriele: Assistant Professor, Department of Accounting, Law & Taxation, Montclair State University. I would like to thank Michael Nieswiadomy (editor) for his extremely helpful comments and recommendations.
James A. DiGabriele