Professors Ayotte & Morrison argue in their recent article from Volume 167 of The University of Pennsylvania Law Review that “the use of ‘company-specific’ or ‘unsystematic’ premiums when calculating the discount rate for future cash flows” has “no reliable basis in finance theory or evidence. These are nothing more than arbitrary add-ons that drive the company’s reported value downward.” They would therefore have judges “rul[e] out problematic assumptions, such as company-specific risk premia” in discount rates and “consistently apply the [Capital Asset Pricing Model (CAPM)].” Indeed, they argue that “methods that allow for ‘company-specific’ premia . . . . fail the Daubert standard of reliability.”Ayotte & Morrison would be on firm ground if they restricted their claim to the valuation of the equity of the handful of publicly traded firms that file for bankruptcy. However, they do not, and both finance theory and evidence support the use of company specific risk premia in other markets. Failing to include these premia will drive the company’s reported value upward, and in bankruptcy overvaluation may be more harmful than undervaluation because those disappointed with a low judicial valuation can sometimes turn to the market for a second opinion.
Unique Risk and Bankruptcy Valuation
(Visited 15 times, 1 visits today)