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Testing for an 'Implied Minority Discount' in Guideline Company Prices

  • Sutter Securities Financial Services, San Francisco


This article discusses how the comparison of acquisition multiples (adjusted for synergies and market conditions) and market multiples can be used for determining minority discounts.
FVLE Issue 19 June/July 2009 Page 4
Sutter Securities Incorporated
San Francisco, CA
Testing for an ‘Implied
Minority Discount’ in
Guideline Company Prices
Delaware has developed a large body
of case law interpreting the Delaware
statute’s appraisal standard in dissent-
ing shareholder cases. The appraisal
statute states, “[T]he Court shall deter-
mine the fair value of the shares exclu-
sive of any element of value arising
from the accomplishment or expecta-
tion of the merger or consolidation,”1
which gave rise to the appraisal pro-
ceeding. Fair value is to be ascertained
on a “going-concern” basis.
Unfortunately, when Delaware
Chancery Court appraisal decisions
have applied the guideline company
method, the court has often incorporat-
ed the concept that guideline company
valuations should be adjusted upward
to offset a presumed “implied minori-
ty discount” (“IMD”).2The Court has
accepted the assumption that the mar-
ket prices of publicly traded shares
represent minority interests. As Vice
Chancellor Leo Strine put it:
The comparable companies analy-
sis generates an equity value that
includes an inherent minority
trading discount, because the
method depends on comparisons
to market multiples derived from
trading information for minority
blocks of the comparable compa-
nies. In a [Delaware] appraisal,
the court must correct this minor-
ity trading discount by adding
back a premium designed to off-
set it.3
This article addresses the
Delaware Court’s misapplication of
control premiums from a business val-
uation perspective.4It focuses on why
it is inappropriate to assume that the
market prices of guideline companies
necessarily include an IMD. A method
is proposed whereby the valuator, in
any specific valuation, can ascertain
whether implied minority discounts
exist in the relevant guideline compa-
ny prices.
Several significant law journal articles
have rejected the theory that market
prices always include an implied
minority discount that must be added
back when calculating the “fair value
of the shares.” In 2001, Professor
Richard Booth wrote, “[I]t is not neces-
sarily the case that actual market price
is always less than fair market price. If
it were, then there would be no such
thing as a fair market price.”5
Professor William Carney also
argued that market prices of most pub-
licly traded shares do not include a sig-
nificant IMD:
[C]ontrol premiums only occur in
transactions involving a transfer
of control, where there are
thought to be gains from trade. . .
Even if all values, both present
and potential, are valued in the
market price for the firm’s shares,
one would not expect to find a
discernible control premium in a
widely held firm that is well man-
aged and appears to offer little
probability of a transfer of control.
Any small probability of a control
transaction will already be reflect-
ed in the market price, because
absent a dominant shareholder,
all shareholders expect to have an
equal opportunity to share in any
such premium, should it appear.
Absent an actual transfer of con-
trol, control premiums represent
probabilities of a control transfer
at a premium. Where the proba-
bility is close to zero, so is the pre-
In order to determine the
amount of adjustment for the premi-
um, Delaware decisions have relied on
average premiums in acquisitions.
Professors Lawrence Hamermesh and
Michael Wachter question this
approach and argue that acquisition
premiums do not support the assump-
tion that market prices necessarily
include IMDs.
[I]t is incorrect to make the logical
jump that these premiums [paid
in acquisitions] reflect some kind
of IMD. The fallacy is obvious
and analogous to the “dogs that
don’t bark” metaphor: there are
lots of dogs, and most of the time,
most dogs are not barking.
Similarly, in any given year, the
vast majority of companies are not
involved in a change of control
They point out that generally accepted
financial theory assumes that market
prices of liquid securities in informed
markets represent going-concern
value. They add, “There is no evidence
that such [market] prices systematical-
ly and continuously err on the low
side, requiring upward adjustment
based on an “implicit minority dis-
Continued on next page
Premiums (if any) to adjust for
implied minority discounts
should be determined by com-
paring multiples of guideline
companies to multiples of
FVLE Issue 19 June/July 2009 Page 5
FINANCIAL VALUATION - Discounts, continued
It is incorrect to assume that market
prices of guideline companies always
include an IMD. Publicly traded
shares may trade higher or lower than
their pro rata portion of the equity
value of the entire company. There are
numerous periods when shares of
companies in some industries have
traded at higher prices than any
prospective cash acquiror would pay
for the entire business. A notable
example is the “” phenomenon
in the late 1990s. Internet-related
shares in the late 1990s commonly
traded at prices well above financial
control value. Therefore, Internet com-
panies were seldom bought for cash,
but were acquired through stock-for-
stock mergers with other Internet com-
In 1990, Eric Nath was the first to
question whether publicly traded
share prices included an implied
minority discount. His position ques-
tioned the conventional wisdom and
argued that market prices generally
incorporated control value. His then-
controversial view was that a compa-
ny’s financial control, positives or neg-
atives, were already reflected in its
freely traded market prices.8
Professor Bradford Cornell
wrote in 1993:
The fact that most companies do not
receive takeover bids at premiums
above market price indicates
investors believe that the shares of
those companies are not worth
significantly more than market
price [emphasis in original].9
In a 1999 article, Shannon Pratt stated,
“Valuation analysts who use the guide-
line public-company valuation method
and then automatically tack on a per-
centage ‘control premium’ … had bet-
ter reconsider their methodology.”10
Mark Lee pointed out in 2001:
If there is no M&A market avail-
able to sell a company at a premi-
um to its stock market value, then
there is little or no acquisition pre-
mium, much less a “theoretical”
premium based on an
average of acquisitions
of dissimilar compa-
Pratt quoted Lee’s 2001
article and added, “[I]t is
obvious that, given the
current state of the
debate, one must be
extremely cautious about
applying a control pre-
mium to public market
values to determine a
control level of value.”12
Lee further point-
ed out in a book chapter
in 2004 that “the acquisi-
tion value of a company
may be equal to or below
its market value.” He wrote, “While a
company may be viewed as very
attractive to a purchaser of a minority
interest in the public market, the com-
pany as a whole may be perceived as
too risky at its publicly traded market
price.”13 In the same book, Matthews
pointed out that when “acquisition
multiples in contemporaneous transac-
tions are at the same level as market
multiples, it makes sense for the ana-
lyst to conclude that no [IMD] is war-
ranted.”14 Philip Clements and Philip
Wisler agreed in their fairness opinion
book, stating, “The control value of a
company may not differ greatly [from]
and may even be below its publicly
traded minority share value.”15
Although Chris Mercer had dis-
agreed with Nath in the early 1990s, he
later came to agree with him. Mercer’s
2004 book The Integrated Theory of
Business Valuation16 included a modi-
fied levels-of-value diagram that
showed “Marketable Minority Value”
overlapping “Financial Control
Value,”17 illustrating his view that the
difference between financial control
value and marketable minority value
could be zero. He commented that
“unless there are cash flow-driven dif-
ferences between the enterprise’s
financial control value and its mar-
ketable minority value, there will be no
(or very little) minority interest dis-
Over the past 20 years, Nath, Lee
and Matthews have often criticized
the use of average acquisition premi-
ums as a fairness standard.20 Average
acquisition premiums paid for shares
of publicly traded companies are sta-
tistically biased because they only
include companies that were attractive
to acquirors and do not include unat-
tractive or overpriced companies.
Therefore, average control premium
comparisons are often a misleading
measure in valuations. As Pratt
observed in 2001:
Out of the tens of thousands of
public companies only a small
percentage actually are acquired
each year. In recent years the
companies purchased have often
been “best of breed,” making
them a very unique subset of the
market. Statistically, it is unlikely
that this small, select group is uni-
versally representative of the mar-
ket as a whole.21
An implied minority discount is fact-
specific in each valuation, and it cannot
be determined by using a generic rule
of thumb.19 The default assumption
ought to be that no IMD should be
applied unless there is specific data
that indicates otherwise. The fact that
some companies have been acquired at
Continued on next page
FVLE Issue 19 June/July 2009 Page 6
FINANCIAL VALUATION - Discounts, continued
a premium over market price does not
demonstrate that all guideline compa-
ny prices include IMD. The key factor
to be considered is the relation
between market multiples and transac-
tion multiples. Although average
acquisition premiums are a poor stan-
dard, there is meaningful data to be
found in guideline acquisitions— the
multiples paid in those guideline
acquisitions. When there is an absence
of recent guideline acquisitions, that
absence in itself evidences that market
prices of the guideline companies are
not at levels that are attractive to
acquirers. In that situation, no IMDs
would be applicable to that guideline
company valuation.
In the situation where guideline
acquisition data is available, the multi-
ples should be compared to multiples
of the guideline companies. If the
guideline acquisition multiples (appro-
priately adjusted to eliminate syner-
gies and market timing) exceed multi-
ples of guideline companies, that fact
indicates that the application of an
IMD should be considered, and the dif-
ference in multiples provides a basis
for its quantification. As part of the
process, the valuator should consider
what adjustment should be made to
multiples of guideline transactions to
eliminate any synergistic benefits
excludable in a Delaware appraisal (or
in other jurisdictions with appraisal
standards similar to Delaware’s).
Additionally, adjustments may be
required for transactions that were
priced at earlier dates under different
market conditions, especially for valu-
ations in today’s depressed market.
It is clear that leading legal and valua-
tion commentators have concluded
that there is no basis for assuming that
market prices of all publicly traded
shares include an implicit minority dis-
count. The default assumption should
be that publicly traded shares sell at a
company’s going-concern value. The
valuator must determine in any given
situation whether or not the guideline
companies should be adjusted for
IMDs. If an analyst con-
cludes in a given situation
that an IMD is appropriate,
its magnitude should be
based on a comparison
between market multiples
and appropriately adjusted
acquisition multiples. F
Delaware Cases in which
an adjustment was made
for IMD:
Hodas v. Spectrum Technology, Inc., 1992 Del.
Ch. LEXIS 252 (Dec. 7, 1992).
Kleinwort Benson Ltd. v. Silgan Corp., 1995
Del. Ch. LEXIS 75 (June 15, 1995).
Borruso v. Communications Telesystems Int’l,
753 A.2d 451 (Del. Ch. 1999).
Bomarko, Inc. v. Int’l Telecharge, Inc., 794
A.2d 11615 (Del. Ch. 1999); affd. Int’l
Telecharge, Inc. v. Bomarko, 766 A.2d 437
(Del. 2000).
Agranoff v. Miller, 791 A.2d 880 (Del. Ch.
Doft & Co., Inc. v., Inc., 2004
Del. Ch. LEXIS 75 (May 21, 2004).
Lane v. Cancer Treatment Centers of America,
Inc., 2004 Del. Ch. LEXIS 108 (July 30, 2004).
Prescott Group Small Cap, L.P. v. Coleman Co.,
2004 Del. Ch. LEXIS 131 (Sept. 8, 2004).
Dobler v. Montgomery Cellular Holding Co.,
2004 Del. Ch. LEXIS 139 (Oct. 4, 2004); aff’d
in part, rev’d in part on other grounds,
Montgomery Cellular Holding Co. v. Dobler,
880 A.2d 206 (Del. 2005).
Andaloro v. PFPC Worldwide, Inc., 2005 Del.
Ch. LEXIS 125 (Aug. 19, 2005).
18 Del. Code Ann. tit. 8, §262(h).
2The IMD is sometimes called an "inherent minority dis-
count" or an "implicit minority discount."
3Agranoff v. Miller, 791 A.2d 880 (Del. Ch. 2001) at 892.
4This issue is discussed in more detail in: Gilbert E.
Matthews, "Misuse of Control Premiums in Delaware
Appraisals," Business Valuation Review, Summer
5Richard A. Booth, "Minority Discounts and Control
Premiums in Appraisal Proceedings," 57 Business
Lawyer 127, p. 130.
6William J. Carney & Mark Heimendinger, "Appraising
the Nonexistent: The Delaware Courts' Struggle with
Control Premiums," 152 U. Pa. L. Rev. 845 (2003), p.
7Lawrence A. Hamermesh & Michael L. Wachter, "The
Short and Puzzling Life of the 'Implicit Minority
Discount' in Delaware Appraisal Law," 156 U. Pa. L.
Rev. 1 (2007), p. 33.
8Eric Nath, "Control Premiums and Minority Interest
Discounts in Private Companies," Business Valuation
Review, June 1990, p. 43.
9Bradford Cornell, Corporate Valuation (McGraw Hill,
1993), p. 243.
10 Shannon P. Pratt, “Control Premiums? Maybe, Maybe
Not - 34% of 3rd Quarter Buyouts at Discounts,”
Business Valuation Update, January 1999, pp. 1-2.
This article is cited in Pratt, Reilly and Schweihs,
Valuing a Business, The Analysis and Appraisal of
Closely Held Companies, Fourth Edition (McGraw Hill,
2000), p. 357.
11 M. Mark Lee, "Control Premiums and Minority
Discounts: the Need for Economic Analysis," Business
Valuation Update, August 2001, p. 4.
12 Pratt, Business Valuation Discounts and Premiums,
2001, p. 40.
13 M. Mark Lee, "The Discount for Lack of Control and
the Ownership Control Premium," in The Handbook of
Business Valuation and Intellectual Property Analysis,
Robert F. Reilly and Robert P. Schweihs, eds.
(McGraw Hill, 2004), p. 37.
14 Matthews, "Fairness Opinions: Common Errors and
Omissions" in The Handbook of Business Valuation
and Intellectual Property Analysis, p. 215.
15 Philip J. Clements and Philip W. Wisler, The Standard
& Poor's Guide to Fairness Opinions (McGraw Hill,
2005), p. 94.
16 Z. Christopher Mercer, The Integrated Theory of
Business Valuation (Peabody, 2004). This book and
its next edition (Mercer and Travis W. Harms, Business
Valuation: An Integrated Theory, Second Edition (Wiley,
2007) innovatively show the interrelation among vari-
ous approaches to valuation, discounts and premiums.
17 Id., p. 110.
18 Id., p. 108.
19 The U.S. Tax Court now requires case-specific analy-
ses and rejects generic discounts for lack of mar-
ketability. See Mandelbaum v. Commissioner, T.C.
Memo 1995-255 (1995); Pratt, Valuing a Business,
Fifth Edition, (McGraw Hill, 2008), p. 449; Michael A.
Paschall, “The 35% ‘Standard’ Marketability Discount:
R.I.P,” CCH Business Valuation Alert, Feb. 2005, p. 3.
20 See, e.g., Nath, pp. 41-43; Matthews and Lee,
"Fairness Opinions & Common Stock Valuations" in
The Library of Investment Banking, Vol. IV, R. Kuhn,
ed. (Dow Jones Irwin, 1990), p. 407; Lee and
Matthews, "Fairness Opinions" in The Handbook of
Advanced Business Valuation, Reilly and Schweihs,
eds. (McGraw Hill, 2000), p. 327; Lee, "Control
Premiums and Minority Discounts: the Need for
Economic Analysis," Business Valuation Update,
August 2001, pp. 2-4; Lee, “The Discount for Lack of
Control and the Ownership Control Premium,” p. 43;
Matthews, "Fairness Opinions: Common Errors and
Omissions," pp. 214-6.
21 Pratt, Business Valuation Discounts and Premiums,
2001, p. 60.
ResearchGate has not been able to resolve any citations for this publication.
Full-text available
Fairness opinions almost always involve an assessment of the value of a company. The question in most fairness opinions is whether a merger or acquisition offer is within an objectively determined range of values for the company or for its shares. In evaluating the fairness of an offer, the analyst is required by law to use valuation methods that are generally accepted. The analyst providing a fairness opinion must expect that the opinion will be scrutinized by the parties to whom it is addressed and will perhaps even be tested in the crucible of litigation. This chapter discusses numerous issues and problems in fairness opinions and valuations, ranging from simple mathematical errors to methodological flaws to broad conceptual issues. Errors that can be laid at the door of the analyst include (I) misinterpretation or misuse of data, (2) failure to recognize mathematical inconsistencies in the data used, and (3) misapplication of generally accepted methods. Some errors, however, derive from flaws in methodologies that have been generally accepted by investment bankers and valuation practitioners. Since analytical methods continue to evolve, it is necessary to be aware of current thinking, to recognize the strengths and weaknesses of various approaches, and to understand when traditional methods need to be reexamined. When an approach is flawed, these flaws should be recognized and corrected. When a concept or method is demonstrably incorrect, either statistically or conceptually, it should be rejected. This chapter points out several areas in which widely used approaches to valuation and to determining fairness should be subjected to critical examination. Some of the broader issues that this chapter will examine include the scope of fairness opinions, the updating of fairness opinions, and the relationship between fairness opinions and the fiduciary duties of directors and control parties. Corporate directors should examine not only the financial aspects of fairness, but also the nonfinancial aspects. In addition, both corporate directors and analysts should also give greater attention to the question of when it is appropriate to update fairness opinions.
Full-text available
In statutory appraisal cases, Delaware Courts sometimes apply premiums that are based on questionable reasoning. They commonly adjust guideline company valuations for an ‘‘implicit minority discount’’, they apply acquisition premiums to subsidiaries, and they often rely upon average premiums in acquisitions as a basis for calculating control premiums. This article discusses the flaws in the reasoning underlying these adjustments.
Full-text available
in a merger, a stockholder often has a statutory right of dissent and appraisal under which the stockholder may demand to be paid fair value exclusive of any gain or loss that may arise from the merger itself. Most courts and commentators agree that a dissenting stockholder should ordinarily receive a pro rata share of the fair value of the corporation without any discount simply because minority shares lack control. In several recent cases, the courts have indicated that a minority stockholder is thus entitled to a share of the control value of the corporation even though the merger does not constitute a sale of control (as in a going private transaction) and even though control of the subject corporation is not contestable (as where a single stockholder owns an outright majority of shares). In a similar vein, several courts have ruled that reliance on market prices for purposes of appraisal results in an inherent minority discount, thus requiring that a premium for control be added. In short, the emerging rule appears to be that fair value is the price at which a controlling stockholder could sell control because failure to do so amounts to imposition of a minority discount. It is the thesis here that the routine addition of a control premium is inconsistent with settled corporation law and good policy because (among other reasons) it is based on the unwarranted assumption that the source of a control premium must be a minority discount. To be sure, the courts should adjust for a minority discount if one is found. But the routine addition of a control premium as part of fair value creates a windfall for dissenting stockholders and infringes the legitimate rights of majority stockholders.
The "implicit minority discount," or IMD, is a fairly new concept in Delaware appraisal law. A review of the case law discussing the concept, however, reveals that it has emerged haphazardly and has not been fully tested against principles that are generally accepted in the financial community. While control share blocks are valued at a premium because of the particular rights and opportunities associated with control, these are elements of value that cannot fairly be viewed as belonging either to the corporation or its shareholders. In corporations with widely dispersed share holdings, the firm is subject to agency costs that must be taken into consideration in determining going concern value. A control block-oriented valuation that fails to deduct such costs does not represent the going concern value of the firm. As a matter of generally accepted financial theory, on the other hand, share prices in liquid and informed markets do generally represent that going concern value, with attendant agency costs factored or priced in. There is no evidence that such prices systematically and continuously err on the low side, requiring upward adjustment based on an "implicit minority discount."Given the lack of serious support for the IMD in finance literature, this Article suggests that the Delaware courts may be relying on the IMD as a means to avoid imposing upon squeezed-out minority shareholders the costs of fiduciary misconduct by the controller. Where either past or estimated future earnings or cash flows are found to be depressed as a result of fiduciary misconduct, however, or where such earnings or cash flows fail to include elements of value that belong to the corporation being valued, the appropriate way to address the corresponding reduction in the determination of "fair value" is by adjusting those subject company earnings or cash flows upward.This approach to the problem of controller opportunism is more direct, more comprehensive in its application, and more in keeping with prevailing financial principles, than the implicit minority discount that the Delaware courts have applied in the limited context of comparable company analysis. The Delaware courts can therefore comfortably dispense with resort to the financially unsupported concept that liquid and informed share markets systematically understate going concern value.
  • Del
  • Ch
Del. Ch. LEXIS 75 (June 15, 1995).
  • Del
  • Ch
Del. Ch. LEXIS 75 (May 21, 2004).
Cancer Treatment Centers of America
Lane v. Cancer Treatment Centers of America, Inc., 2004 Del. Ch. LEXIS 108 (July 30, 2004).
  • Prescott Group Small Cap
  • Coleman Co
Prescott Group Small Cap, L.P. v. Coleman Co., 2004 Del. Ch. LEXIS 131 (Sept. 8, 2004).
  • Del
  • Ch
Del. Ch. LEXIS 139 (Oct. 4, 2004);