The valuation lore with many valuation analysts who cite “the restricted stock studies” (and seldom much more) is that the “typical” range of restricted stock discounts is from about 25% to 45%, with an average of about 35%. This post addresses, and hopefully kills, this myth.
This is the fourth post in a series on restricted stock discounts and studies based primarily on Chapter 8 of our (Mercer and Harms) forthcoming third edition of Business Valuation: An Integrated Theory. The book will be available on Amazon.com and from other booksellers in mid-October. The series thus far:
- The Silber Study of Restricted Stock Discounts – 1991. This post repeated a long-ignored study by Professor Silber that should have told us that averages mean nothing.
- Restricted Stock Discounts: the Expected Holding Period Premium is the Cause. We examine the logic and math of the only difference between restricted shares and their freely traded counterparts that created restricted stock discounts.
- Quantifying Expected Holding Period Premiums in Restricted Stock Transactions. Using the logic of one hypothetical restricted stock transaction, we estimate the expected holding period and calculate a range of expected holding period premiums.
In today’s post, we tackle the myth that the “typical” range of restricted stock discounts is 25% to 45%, with an average of about 35%.
Did you ever wonder why so many valuation analysts conclude that the marketability discount in the valuation of illiquid minority interests, almost regardless of the characteristics of individual interests, is about 35%, plus or minus a bit?
First, we let’s talk about the sources of this myth. By the early 1980s, there were a handful of studies that investigated the purchases of a number of publicly-traded closed-end investment funds that began to finance smallish public companies that did not have alternative sources of financing.
Because both the companies issuing restricted shares and the closed-end fund investors were publicly-traded, the price and certain details of transactions had to be provided in public disclosures of the companies and the funds. The Securities and Exchange Commission published the first study in 1971. The SEC Institutional Investor Study (“the SEC Study”) covered 398 transactions that occurred between 1966 and 1969. The median and mean of the transactions were 24% and 26%, respectively. The range of restricted stock discounts in the SEC Study was very wide, from a premium of 15% to a high discount of 80%.
That study was bookended by a 1983 study of 28 transactions performed by Charles Stryker and William Pittock in their company newsletter. The median discount was 45%, and no average was provided. Again, the range of discounts was wide, from 7% to 91%. There were two studies in between these two (Gelman and Maher).
Throw in the 1991 Silber Study, the subject of the first post in this series, which had an average discount of 34% and a range from a premium of 13% to a high discount of 84%. We already know that the central message of that study has been ignored by valuation analysts for decades.
And look at the 1993 Maloney Study, which had median and mean observations of 34% and 35%, respectively.
The die that 25% to 45% was the “typical” range of discounts was set. Take a moment to examine a summary of these studies and a bit more from Exhibit 8.15 of the third edition of Business Valuation: An Integrated Theory.
The studies I just mentioned are summarized in the first six rows of Exhibit 8.15. The medians and averages are highlighted to facilitate review. At the upper left of the highlighted area, we see the median and mean of the SEC Study of 24% and 26%, respectively. That is the basis for the 25% lower end of the mythical range of restricted stock discounts.
On the fourth row, we see the median of the Stryker/Pittock Study of 45%. That is the basis for the upper end of the mythical range of 45%.
All the other observations are in the range of 33% to 35%, which provides the basis for the so-called “typical” restricted stock discount of 35%.
Assuming there were no duplicate transactions in these six studies, which there almost certainly were, a good portion of the valuation profession has been relying on this information for nearly four decades. Note the following regarding the first six studies:
- There were at most 764 transactions.
- The earliest transactions occurred in 1966 an the latest transactions occurred in 1988. This means that valuation lore is based on transactions that occurred somewhere between about 32 and 54 years ago.
- The first of the six studies was published in 1971 and the last was published in 1993. These studies were published between 27 and 49 years ago.
One last observation from Exhibit 8.15: No study has been published since the Moroney Study in 1993, which has supported the mythical range of 25% to 45% as typical for restricted stock discounts.
If dissemination of this post and the related content in our new book does not kill the myth of 25%/45%/35% in business appraisal, it will likely never die.
The third edition of Business Valuation: An Integrated Theory will be available in mid-October. Let me suggest not so immodestly if I may:
- If you are a valuation analyst, you need to obtain and read the book. There is no other book on the market remotely addressing valuation theory in the understandable way that is done in the third edition.
- If you supervise valuation analysts, you need to be sure that every one of your analysts has their personal copies of the book for ready reference.
- If you are teaching valuation courses of any kind, you need to obtain and read the third edition.
- If you are a market participant in a business where business valuation is important for mergers and acquisitions or other reasons, you need to obtain and read this book.
Please do take the time to comment on this post below. The valuation profession needs open discussion, and it can begin with many of us, including you.
Until the next post, be safe and be well.