Academic journal article Journal of Legal Economics

Uncertainty Disclosure in Disputed Business Valuations

Academic journal article Journal of Legal Economics

Uncertainty Disclosure in Disputed Business Valuations

Article excerpt

Abstract: For every circumstance that leads to the need for a business valuation - e.g. M & A, a shareholder derivative action, estate planning, bankruptcy - there are at least as many reasons for the valuation to be disputed as there are entities who will be affected by a relatively high or relatively low value: buyer and seller negotiating a purchase price, minority and majority shareholder arguing over the value of an interest, business owner and the U.S. Treasury calculating a tax exposure, senior and junior creditors bargaining in a reorganization, etc. This paper presents a metric for incorporating valuator-generated measures of uncertainty in competing valuations, and a resolution protocol based on that metric which avoids some of the well-known problems associated with simple averaging or Final Offer Arbitration. Considering the dispersion of each valuator's estimate and creating the threat of a third-party unbiased estimate increases the likelihood that an extreme estimate will be discarded or discounted. By focusing not only on the point estimate but also on its variability, the process creates incentives for settlement.

(ProQuest: ... denotes formulae omitted.)

I. Introduction

For every circumstance that leads to the need for a business valuation - e.g. M & A, a shareholder derivative action, dissolution of a joint venture, estate planning, bankruptcy - there are at least as many reasons for the valuation to be disputed as there are entities who will be affected by a relatively high or relatively low value: buyer and seller negotiating a purchase price, co-venturers A and B dissolving a partnership, minority and majority shareholder arguing over the value of an interest, business owner and the U.S. Treasury calculating a tax exposure, senior and junior creditors bargaining in a reorganization. "Uncertainties accompany any valuation procedure," (Baird & Bernstein 2006:1935) and these uncertainties include "...uncertainty regarding the true value of an enterprise ("actual uncertainty") and uncertainty regarding the value that a judge would assign to the enterprise ("judicial valuation uncertainty")." (O'Rourke 2005:414; also see Black 1986)

In the circumstance where each party in a dispute has provided plausible and economically-grounded valuations, it can be quite challenging to determine whether both, neither, or just one of the submitted valuations provides the best basis for settlement. This paper provides a resolution tool which uses information provided by the disputants and guides the judge as to when the services and costs of a neutral third-party opinion should be imposed on the process, and when it might be fair to proceed without them.

Judges preside over valuation disputes that arise in bankruptcy cases, commercial disputes, tax cases, etc. Baird and Bernstein (2006:1937) note that "...the reorganization of an insolvent enterprise is the equivalent of a going-concern sale of the business to its creditors in exchange for their claims." The literature of bankruptcy reorganization provides an especially rich resource on the incidence and variety of financial and gaming issues in a judicially administered decision process. This paper therefore uses the term "judge" in a general sense, so that it applies equally to arbiters and other individuals with the authority to impose a determination of value. Although most judges are primarily legal experts with relatively less expertise in economic and financial issues, it has been noted that, "Judicial opinions typically benefit from input representing several diverse and sophisticated perspectives. In this light, judicial valuation is an indirect but articulate reflection of how valuation is practiced in the greater financial community." (Yee, 2008 a)

While the technique presented in this paper is easy to apply, it imposes two potential costs on the resolution process: First, there may be a need for support from a consulting statistician for the judge, and, secondly, there may be a need for a court-appointed valuator. …

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