The Art of Valuation

Anyone who has ever litigated a valuation issue knows that valuation is more art than science. Experts often arrive at widely divergent valuations. Yet, these valuations are of the same company, for the same time period, based on the same data, and often invoke the same model. How then can the valuations be so different and, more importantly, which expert is right? Valuations of course can vary for a number of reasons, including different assumptions and inputs, and sometimes because of the methodology itself. But as one of my very astute students in Corporate Finance recently pointed out, valuations also likely differ because of the legal position (he actually used the term "self-interest") of the party employing the expert and offering the particular valuation into evidence.

I actually am a strong proponent of judicial valuation, despite the potential gamesmanship and uncertainty inherent in valuation testimony. I think the process subjects the valuation to greater scrutiny, better protects under-represented parties, and encourages consensual resolutions. The ABI Commission endorsed the continued use of judicial valuation, as well as the ability of judges to appoint valuation experts to perform an independent assessment of the valuation (see here).

The ABI Commission also considered the impact of fluctuations in valuation on creditor distributions. For example, a company typically files bankruptcy at its lowest point—e.g., the business, industry, or general economy is depressed. If the company proposes to sell its assets quickly in the chapter 11 case, should creditors be stuck with that depressed valuation? I discuss this particular issue and the ABI Commission’s related recommendations on foreclosure value, reorganization value, and redemption option value here in a short piece on The Columbia Law School’s Blue Sky Blog.

Valuation issues are among the most difficult in chapter 11 cases. They affect the company’s liquidity and financing options and often fix creditor returns in the case. The stakes are high, and small discrepancies can have huge consequences. Accordingly, some innovation and new approaches to valuation may be exactly what we need.

*Note: The views expressed in this post are those of the author and are intended to spark a meaningful dialogue about chapter 11 reform. They are not attributable to the American Bankruptcy Institute or the ABI Commission to Study the Reform of Chapter 11.

Valuation image from Shutterstock.

Comments

[Robert White]

Or, in trumping the experts over value, the court’s predisposition to the “melting ice cube theory” favoring expediency puts value second; ie. as John Maddenn says - “you can only have one worse pain at a time”.

[Amos]

When equity analysts value a company, their conclusions rarely differ by more than a cent or two. Blaming self-interest for way-off bankruptcy valuations is silly; the valuations are off because the parties feel they can get away with submitting badly-off valuations. They feel that way because the courts and the bar don't understand what they're looking at.

Have you ever actually litigated a valuation issue? I promise you, both sides know where each of their experts is probably right and probably wrong. Most of the time anyway.

Having one valuation expert instead of two hardly addresses that problem.

[Michelle Harner]

Amos and Robert—Thank you for your comments.

Amos, with respect to your comment and question: I actually was involved in valuation litigation frequently during my ten years of practice at Jones Day. Some of those battles were quite interesting. I think many lawyers and judges understand DCF, CAPM, WACC, etc., and where the play is in valuation contests. As such, I agree with your statement that “both sides know where each of their experts is probably right and probably wrong.” Along those lines, a court-appointed valuation expert typically is in addition to—not in lieu of—the parties’ respective experts. A court-appointed valuation expert can assist the court in working through each valuation and help identify the most appropriate valuation at that point in time. Also, I do not think it is the only or perhaps the best way to tighten the valuation process in bankruptcy, but it is one way and certainly alternative options should be explored.

[Michelle Harner]

One additional thought here for everyone to consider. When I use the term "valuation litigation," I am using that term broadly to capture the various valuation disputes we have in chapter 11--adequate protection, priming, sales, plans, claims resolution, etc. Often that litigation never reaches trial, so the possibility of judicial valuation may be even more relevant than what the courts actually do. I raise this because of Amos's fair point about whether one expert solves (or even mitigates) the problem, and of course you have a cost factor when you add a third. That being said I was intrigued by Adam Levitin's post on valuation yesterday and his "baseball salary arbitration" approach. I wonder if that might discipline the process some and help the parties achieve consensus quicker.