Einstein and Valuation: It’s All Relative!

It’s Responsible and Efficient to Begin Appraisals by Granting Certain Assumptions and Respecting Precedent. Here’s Why.

All kinds of news, findings, and rulings come out that might affect the work of financial consultants and appraisers every day. When can you know when a precedent is important or something you can ignore? Or, put another way: what information is most important to pay attention to? Rand Curtiss explains.

Einstein and Valuation: It’s All Relative!

A few weeks ago, physicists announced a startling experimental result: certain particles traveled faster than the speed of light. If it is confirmed, this will invalidate Einstein’s theory of relativity, which has stood for over a century! The key phrase in the preceding paragraph is “if it is confirmed.”

Other physicists will now study the published experimental results, searching for possible flaws, and try to duplicate it independently. That may take a few years: until then, Einstein can rest (relatively!) comfortably.

The principle of confirmation applies to appraisers in two areas: academic/professional studies and court cases. Stout Risius Ross recently published a new restricted stock discount study.

Did any of us who read it radically change our lack of marketability appraisal procedures?

Of course not: We just updated the list of such studies we cite in our reports. Only if someone publishes an anomalous result or draws a dramatically different conclusion from the data do we get excited, study the results, look for flaws, and try to duplicate (confirm or invalidate) them, just like those physicists.

The same thing applies to court cases. New rulings come out every day. Cases are not probative (constituting valid evidence) for us. We do not have all the facts (court transcripts are not always complete, we cannot know whether the “losing” attorney or appraiser did a bad job, and so forth). Moreover, we are not lawyers. We should not cite court cases in our reports. To do so opens us up to brutal cross examination (“Mr. Smith, are you a licensed attorney?”). We have to stick to financial theory, generally accepted practice, and market studies of the types referenced above.

Only when new laws or court cases establish new precedents (legal principles) should we be concerned. Obviously, if Congress changes corporate tax rates, our corporate valuation conclusions will change. Less obviously, we should look to higher-level court rulings to determine if new precedents are set. (Do this with the aid of an attorney.)

At the federal level, this means the Tax Court or higher. At the state and local level, this varies: courts at different levels have different names in various states and localities.

Just because a local court in Ohio rules in a particular divorce case that there was no lack of marketability discount for a marital minority stock interest, that does not mean anything for anyone, except perhaps in that specific jurisdiction.

A good example of a possible new precedent is the tax effecting of “S” corporation earnings. After a “do not tax effect” ruling was issued by the Tax Court in 2000 (the Gross case), a number of appraisers developed and generously published sound, logical, factual financial models that rigorously compared cash flows to equity for Fourth Quarter 2011 9 Business Appraisal Practice “S” and “C” corporate shareholders.

Still others conducted and published market studies to see if the election made an empirical difference. We can use THAT kind of logic and information in our appraisals!

Rand M. Curtiss, MCBA, FIBA, ASA, ASA is President of Loveman-Curtiss, Inc. in Cleveland, OH.