Journal of Applied Research in Accounting and Finance
Vol 5 (1) July 2010
On the Myth of Size Premiums in Corporate Valuation: Some Empirical Evidence from the German Stock Market by Jörg Baetge, Hans-Jürgen Kirsch, Peter Koelen and Roland Schulz
It is common practice in corporate valuation with discounted cash flow models to refer to the Capital Asset Pricing Model (CAPM) to estimate the rate of return required by investors. However, based on empirical studies of the US stock market - primarily Ibbotson and Morningstar (2008) and Grabowski and King (2008) - there is increasing debate in Germany about whether to adjust the discount rate by adding a size premium for smaller companies as valuation advisors already partially do in the US and several other countries. Since a relatively small size premium leads to an enormous collapse in value, the discussion of whether to adjust for size is all but negligible.
Finding contradicting empirical results for the German stock market between 1995 and 2008, this paper questions the size adjustment in corporate valuation. However, it is not just empirical evidence that casts doubt on size premiums. There are also conceptual aspects that conflict with adjusting the CAPM through simply adding an additional risk premium. This paper tries to give a more comprehensive but critical view on corporate valuation with respect to size.
Discussion of the Pre and Post-Tax Discount Rates and Cash Flows: A Technical Note by Jan Jindra and Torben Voetmann
Lonergan (2009) appropriately recommends that "discounted cash flow analysis should be configured on the basis of post-tax cash flows discounted with post-tax discount rates." We generally agree with his recommendation when it is applied in discounted cash flow valuations due to accounting conventions that affect post-tax cash flows. However, we show that when valuing cash flows with a well-defined marginal corporate tax rate, the present value of pre-tax cash flows discounted at a pre-tax discount rate exactly matches the present value of post-tax cash flows discounted at a post-tax discount rate. We present analytical examples to demonstrate this equality.
Calculation of Damages When Shareholders Sue Their Company by Tom Valentine
A methodology commonly used to calculate losses in shareholder actions against companies for failing to announce information relevant to the share price is based on price movements shortly after the ultimate announcement. This approach will lead to an overestimate of the loss if the market overreacts to the information. It can also lead to a wide range of estimates of loss. A better measure of the loss would be the loss in the intrinsic value of the company attributable to the new information. These arguments are illustrated by the recent case of Downer EDI.