Deja Vu #4: The Moroney Restricted Stock Study (1973)

This is the fourth post in a series on the historical restricted stock studies that appraisers have referenced for many years and is a review of the Moroney Restricted Stock Study.  The first three posts in the series addressing can be viewed: 1) SEC Rule 14 pre-April 1997, 2) the SEC Institutional Investor Study, and 3) the Gelman Study and the Trout Study.

Robert Moroney gave a speech to the Texas CPA Institute in November 1972. His remarks were published in article form in Taxes in early 1973.[1] In the article, Moroney reviewed the Tax Court’s treatment of marketability discounts for closely held stocks in 12 decisions from about 1960 through 1971. He then compared the discounts allowed in the cited cases with the discounts required by ten investment companies in their purchases of restricted stock of publicly traded companies.

Moroney’s central finding was that the Tax Court had embraced the concept of marketability discounts, but had been reluctant to grant discounts commensurate with their economic reality in the marketplace.

The Moroney study is an articulate and well-reasoned early article on marketability discounts. Most analyses of Moroney’s material, however, have involved only a review of the review provided in Pratt’s Chapter 15 (VAB3), in which he summarized all these articles in about six pages.[2] In his Moroney review, Pratt focused on the median and average discounts for the restricted stock study in the article.

The Tax Court and many appraisers have given great credence to the 35% or so discount which is the approximate median/mean conclusion of the Moroney study (see below). We should, however, consider his measures of central tendency in the context of his entire analysis.

In his discussion of cases, Moroney notes three important issues for consideration regarding marketability discounts.

  • Expert witnesses. There are no “rules” for establishing marketability discounts.[3] In the absence of guidance from the IRS, expert witnesses can be vital in explaining the use of marketability discounts to the Tax Court.
  • Dividend yield. While many publicly traded common stocks are purchased in the expectation of capital appreciation, dividend yield is a singularly important factor in the valuation of closely-held stock. Dividend yield provides current cash flow to the holder of a closely held stock and helps compensate for a potentially lengthy (and indeterminate, and certainly uncertain) holding period until some form of liquidity is achieved. Moroney is specific on this point:

The typical buyer of a minority interest in a closely held corporation has every right to insist on an adequate dividend yield because, his stock having no marketability, he must be prepared to hold it for an indeterminable period of time – maybe years, maybe decades – before some event will enable him to bail out, hopefully at a profit.[4]

Moroney suggests comparing the dividend yields of minority interests of closely held corporations at their discounted valuations to that of fully marketable securities at the valuation date.[5] This is a fairly obvious point, but the importance of dividends on closely held, nonmarketable minority shares, which was very important to the earliest students of marketability discounts, seems to have been overlooked in much of the current discussion on the subject.[6]

  • Other (inside) stockholders as “market-makers.” Moroney reacted to the suggestion in some Tax Court opinions that the other (inside) shareholders, particularly members of a control group, might automatically create a market for minority shares at premium prices, thereby mitigating any marketability discount. Moroney’s interesting discussion on this issue concludes as follows:

In the deGuebriant case, the court said: “…We recognize that stock in such a closed corporation is hard to sell, there being no other market than that afforded by the few other stockholders.”  Question: Do the other stockholders really provide a market?  Maybe yes, maybe no, depending upon all the facts of each separate case. Among other variables, much would depend on whether the other stockholders were happy or unhappy with their own holdings. Some stockholders might not buy more of the company’s stock even at gunpoint.”[7]  [emphasis added]

We interpret Moroney to be suggesting that if there is no active market, there is no active market, and the valuation analyst must carefully analyze this fact and consider the actual market in any determination of a marketability discount. We also interpret Moroney as suggesting that actual sellers of closely held stock face the same set of economics as prospective buyers. This point will be reemphasized in a later post.

Moroney provided a tabular analysis of some 29 court cases involving the concept of marketability discounts. Writing in 1972, he observed that 20 of the 29 cases explicitly upheld the concept of marketability discounts and that the remainder implicitly employed a discount related to the lack of marketability. Figure 2-5 provides a summary of the cases noted by Moroney that considered a marketability discount, either specifically or in combination with other discounts.

In the 1962 Drybrough case, the Tax Court concluded that a marketability discount of 35% was appropriate. This represents the upper end of discounts for minority interests in the cases cited.

In assessing the cases, Moroney discussed the results of the SEC Study, which validated the use of higher discounts than found in the cases. He also introduced a study of the purchases of restricted stock by ten registered investment companies. Moroney examined their holding of restricted shares “at recent dates.” His analysis of “original purchase discounts” is summarized in Figure 2-6.

Moroney commented on the disparity between sales of restricted stock of publicly traded companies with the results of court decisions related to marketability discounts for nonmarketable minority interests of closely held companies.

Astonishing indeed to many interested people is the discovery that those discounts were as deep as 50 percent, 52 percent, 57 percent, 62 percent, 66 percent, 81 percent, 87 percent, and even 90 percent. Contrast those actual cash deals with the adjudicated discounts of only 10 percent in Bader, 10 percent in Worthen, 12 percent in Central Trust Co., 20 percent in Bartram, 25 percent in deGuebriant, 33 1/3 percent in Obermer, and 35% in Drybrough.[8] [emphasis in the original]

Moroney concluded in 1973 that the taxpayer had not received fair treatment. Figure 2-7 further illustrates Moroney’s analysis by creating a frequency distribution of transaction discounts included in his study.

About 45% of the discounts in the Moroney study are under 30%. Alternatively, some 55% of the discounts were 30% or greater. The mean discount in the study was 35.6%, and the median was 33%. The standard deviation is 18%, indicating a fairly wide dispersion about the mean, which can be confirmed by a visual examination of  Figure 2-6.

In reviewing the prospectuses and annual reports of the ten registered investment companies in his study, Moroney gleaned several “helpful reminders” of the many factors to be considered in the difficult process of valuing restricted securities.

  • Impact of liquidity. In addition to noting the original issue discounts above, Moroney’s analysis of public disclosure documents showed that deep discounts were required even when a restricted stock was in registration for a public offering. The fund managers disclosing value were apparently concerned with the many uncertainties involved in the process of going public and were reluctant to give much “credit” for the expected initial public offerings in their valuations of restricted stock purchases.
  • Indeterminate holding period. The holding period for closely-held shares can vary considerably. In the case of the restricted stock transactions under study, “the issuing corporations, almost without exception, agreed to register the securities under stated conditions.”[9] In the early 1970s, the holding period expectation prior to registration was two-to-three years, depending upon circumstances. Moroney states:

In contrast, most hypothetical buyers of most minority interests in closely held companies involved in tax cases haven’t the foggiest idea as to when or how they will be able to sell. There is no light at the end of the tunnel. Literally, in many instances, the buyer must prepare himself to hold the stock for an indeterminable period of time, maybe for as long as a generation.[10]  [emphasis added]

  • The general attractiveness of the investment. Moroney suggests that in order to have been considered for the portfolio of the various funds, the subject companies had to pass the analytical review of a fund’s staff and investment committee and be judged a good investment risk.

Moroney indicates a possible correlation between the lack of promise of some privately owned businesses and the related marketability discount. We would suggest that there is a potential for double-counting of discounts if this argument is carried too far. We do agree with Moroney’s general proposition that one must look at all relevant factors that might differentiate a nonmarketable minority interest in a closely held company from marketable minority interests in existing public companies when there is a reasonable expectation of liquidity within a couple of years or so.

Moroney concludes with the following observations:

Obviously, the courts in the past have overvalued minority interests in closely held companies for federal tax purposes. But most (probably all) of those decisions were handed down without the benefit of the facts of life recently made available for all to see.

Some appraisers have for years had a strong gut feeling that they should use far greater discounts for non-marketability than the courts had allowed. From now on those appraisers need not stop at 35 percent merely because it’s perhaps the largest discount clearly approved in a court decision. Appraisers can now cite a number of known arm’s length transactions in which the discount ranged up to 90 percent.[11]

Current Comments. The Moroney Study seems to advocate generally higher (than previously granted in Tax Court decisions) marketability discounts.  On the other hand, the study clearly states the need to examine the potential for dividend yield, the impact of (il)liquidity, the fact of indeterminate holding periods, and a catch-all, the general attractiveness of investments.

Just to be clear regarding Moroney’s suggestion of how to look at dividend yields for closely held business interests, look at the following figure.

It is fairly obvious, but Moroney suggested looking at dividend (or distribution) yields from the viewpoint of hypothetical investors and based on the concluded illiquid minority values after any marketability discount is applied.  In the example above, the expected dividend yield from the viewpoint of investors is 7.1%, and not 5.0%.  This fact adds to the attractiveness of the investment.

In the next post, we will examine the Maher Restricted Stock Study, which was published in 1976.  In that review, we will show a scatter diagram of all the transaction discounts in both the Moroney and Maher studies.  You can’t wait to see it!☺

In the meantime, be well,



[1] Moroney, Robert E., “Most Courts Overvalue Closely Held Stocks,” Taxes – The Tax Magazine, March, 1973, pp. 144-155.

[2] Pratt, Shannon P., Reilly, Robert F., and Schweihs, Robert P., Valuing a Business: The Analysis and Appraisal of Closely Held Companies, Third Edition (Chicago, IL, Irwin Professional Publishing 1996). pp. 336-342. Dr. Pratt provides excellent summaries focusing on the average discounts found in the various studies, and provides precise references to the source articles. The previous editions of Valuing a Business also included these summaries. Unfortunately, most business appraisers have never read the source articles. I have asked for a show of hands at several speeches I have given on the subject and at best, only a relative few acknowledge having read all or most of the original studies.

[3] Moroney cites the IRS Code §2031(b) to indicate the absence of guidance regarding marketability discounts. There is, for example, no mention of the concept of marketability discount in Revenue Ruling 59‑60.

[4] Ibid, p. 146.

[5] In other words, a willing buyer of closely held shares will compare the potential yield on (discounted) value with yields available elsewhere in the marketplace from marketable securities in the determination of ultimate pricing. This point is also made in the Maher article below.

[6] In this regard, appraisers should not confuse the reality of actual (cash) dividends historically and the clear expectation of future (cash) dividends with dividend capacity. Hypothetical and real investors cannot spend or reinvest a company’s capacity to pay dividends.

[7] Ibid, p. 147.

[8] Ibid, p. 151.

[9] Ibid, p. 152.

[10] Ibid, p. 152.

[11]  Ibid, p. 154.

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