Patrick Anderson

The Economics of Business Valuation

Towards a Value Functional Approach

• Gebundenes Buch

Produktbeschreibung

This book brings to light an expanded valuation toolkit, ultimately arguing that the "value functional" approach to business assessment avoids most of the shortcomings of its competitors, and more correctly matches the actual motivations and information set held by stakeholders in a business valuation.

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Produktdetails

• Verlag: Stanford University Press
• Seitenzahl: 440
• Erscheinungstermin: 10. April 2013
• Englisch
• Abmessung: 257mm x 183mm x 28mm
• Gewicht: 930g
• ISBN-13: 9780804758307
• ISBN-10: 0804758301
• Artikelnr.: 34748478

Autorenporträt

Patrick L. Anderson founded Anderson Economic Group in 1996 and serves as a Principal and Chief Executive Officer in the company. His recent books include Applied Game Theory and Strategic Behavior and Business, Economics, and Finance with Matlab, GIS, and Simulation Models.

Inhaltsangabe

The Economics of Business Valuation: Towards a Value Functional Approach
Author(s): Patrick L. Anderson
For decades, the traditional approaches to business valuation (market,
asset, and income) have taken center stage in the assessment of the firm.
This book presents an expanded valuation toolkit, consisting of nine
well-defined valuation principles hailing from the fields of economics,
finance, accounting, taxation, and management. It ultimately argues that
the "value functional" approach to business valuation avoids most of the
shortcomings of its competitors, and more correctly matches the actual
motivations and information held by stakeholders. To remedy the
shortcomings of existing theory, the author proposes a new definition of
the firm that is consistent with the principle that entrepreneurs maximize
value, not profit.
1Modern Value Quandaries
The author traces the importance of the business, company, or firm in
Economics, society, and world history over two millennia. The author notes
that, given its importance and centrality in modern economies, there should
be a well-developed theory of the firm that pervades both Economics and
Finance. However, a series of "quandaries" are posed that illustrate that
this is not the case. These include the fact that neoclassical economics
essentially ignores the firm, that mainstream Economics largely ignores the
entrepreneur, and that real entrepreneurs do not maximize profits.
Furthermore, much of Finance focuses on publicly-traded firms, while 99% of
firms are privately held, and mathematical finance often assumes complete
markets, which are a rarity in the actual world. These provocative
statements motivate much of the theory and applications developed in the
rest of the book.
2Methods and Theories of Value
This chapter reviews the common definition of "market value" in Economics,
and the practical use of the term in tax, accounting, and other fields. It
then introduces ten different valuation theories. Among these are three
different valuation principles derived from the Economics literature, three
traditional methods of valuation, three from Mathematical Finance, and one
novel principle that emerges from both Economics and Control Theory. Each
of these is based on principles distinct from each other, in the sense that
each fundamentally derives "value" from a different source.
3The Failure of the Neoclassical Investment Rule
This chapter presents telling evidence that the value of a firm is not the
net present value of its expected profits. This is a provocative statement,
and deserves careful support: the notion that the value of investments in
firms is the expected net present value of their earnings is a pillar of
Finance. The author summarizes the intellectual history of this notion, and
then presents six major failings of the "NPV rule," in particular, that
decision-makers often don't follow this rule.
4The Nature of the Firm
This chapter presents three competing definitions of the firm, including a
common definition of any organization that has a profit motive, a modern
neoclassical definition of a transaction institution whose incentives
differ from those of its owners, and a new three-part definition. The
elements of the new definition of the firm include an organization with a
profit motive for its investors, a separate identity, and replicable
business practices.
5The Organization and Scale of Private Business
This chapter presents the available information on the number of businesses
in the United States, and the number by size class, the share that fulfill
a common definition of "small" business, and the data on survivorship rates
for newly-established businesses in multiple countries. It critically
examines the stylized facts about such businesses in the United States.
Finally, it provides updated data on the value of privately-held businesses
in the U.S., following the methodology of Anderson (2009). Those data
suggest that equity in privately held firms form a larger share of
household assets than stocks in publicly-traded firms among U.S.
households.
6Accounting for the Firm
This chapter focuses on the history, proper role, and limitations of
accounting. It covers the vital role of accounting in business, why
accounting is not the same as valuation, management, or finance, the
history of accounting, and principles of accounting, starting with the most
important one: ethics, as well as the historical cost principle.
7Value in Classical Economics
The author begins a review of 10 different theories of value with this
chapter on classical economic thought. The labor theory of value dates as
least as far back as Adam Smith and the 18th century, and may have
independently been articulated by the Indian sage Kautilya in the 3rd
century BC. The author observes that the labor theory fails to explain the
actual determination of prices in a market economy, but still provides
valuable insight into human behavior in the modern economy.
8Value in Neoclassical Economics
The neoclassical model is familiar to generations of college students. This
chapter reviews the emergence of the neoclassical or "marginalist" school
of economics in the late 19th century, and its formal elements and basic
mathematics. It notes elements of the theory that are not settled: utility,
risk aversion, and time preference, and discusses the critique of the
"behaviorist." The author then tests the neoclassical model as a practical
valuation tool for a business, applying it to three actual businesses. This
analysis shows the neoclassical model is not a practical valuation tool.
9Modern Recursive Equilibrium and the Basic Pricing Equation
The author introduces the "recursive" model that has emerged within
micro-economics over the past few decades. This modern recursive
equilibrium model is contrasted with the neoclassical model, in terms of
the optimization and time periods involved. The modern, multi-period
consumer savings problem is introduced, as well as the "cake eating"
problem and basic pricing equation. The author argues these form the basis
of a modern microeconomic theory, and that the stochastic discount factor
that emerges from the basic pricing equation provides a valuable insight
that is lacking in the neoclassical and classical worlds. As with other
valuation principles, the author tests the principle as a practical
valuation tool for three actual businesses, demonstrating that is provides
an incomplete basis for valuation of private firms.
10Arbitrage-Free Pricing in Complete Markets
The author describes one of the breakthrough concepts of modern finance:
the use of the no arbitrage principle in complete markets as the basis for
the powerful mathematics of "risk neutral" or "equivalent martingale"
pricing. This neoclassical finance model relies on two intertwined
assumptions: the existence of complete markets, and the assumption that
market participants will act to ensure that no arbitrage profits are
possible. The author then presents strong evidence that both of these
assumptions are lacking for private businesses and their investors, because
markets for the equity in these firms are incomplete. The author argues
that this severely undermines this model as a practical valuation tool. As
with other principles, this assertion is tested by applying it to three
actual companies.
11Portfolio Pricing Methods
The idea of business investments assembled as part of an investment
portfolio is a powerful one with ramifications that extend to the pricing
of individual investments. The author describes the mean-variance
framework, as outlined by Harvey Markowitz in the 1950s, as establishing
the basis for an entire class of Modern Portfolio Theory models. The author
then outlines the relationship between portfolio models and the Basic
Pricing Equation, the most familiar of the portfolio models, the Capital
Asset Pricing Model, including a recursive derivation of the CAPM that is
somewhat closer to actual household behavior than the typical presentation,
and the Roll critique of CAPM and similar models, and extends that critique
noting that equity in 99% of firms do not fit into portfolio models.
Portfolio models are then tested to see if they provide a practical basis
for valuing three actual firms.
12Real Options and Expanded Net Present Value
This chapter demonstrates the importance of management flexibility
regarding the timing, scale, and type of investments, which is the basis
for the study of "real options." The chapter describes an opportunity and
its contractual equivalent, an option, the history of option contracts, the
classic Black-Scholes-Merton option model of the firm, and the formula for
pricing, under ideal conditions, a pure financial call option. From this
basis, the author draws the conclusion that the existence of an option
premium alone renders invalid the Net Present Value rule for the value of
the firm. The author then describes techniques for valuing "real options,"
including extensions of financial options methods, Decision Tree Analysis,
Monte Carlo, stochastic control, and value functional models, and "good
deal" bounds. Finally it describes a recently-proposed synthesis of
traditional income methods and real options analysis, which the author
calls "expanded net present value" or XNPV.
13Traditional Valuation Methods
This chapter describes the three traditional methods of valuing a business:
the market approach, asset approach and income approach. For each, he
describes a valuation principle and an underlying mathematical equation.
The author describes the income or "discounted cash flow" approach is a
workhorse of practical valuation. He observes the heavy reliance on
subjective adjustments in actual use of this approach, which he argues
supports the critique of the net present value rule and the weakness of
this and other approaches in which subjective judgment, rather than actual
use of a method, is the dominant factor. Finally, two of these traditional
approaches are used to value three example firms, with the weaknesses in
certain methods and the dominance of subjective adjustments made apparent.
14Practical Application of the Income Method
The author focuses in this chapter on the workhorse income approach to
valuation. Based on his extensive practical experience, he discusses the
essential steps of forecasting future business revenue, identifying income
arising from that revenue, and discounting that future income for time and
risk. The author argues that, while each of these tasks are important,
forecasting business revenue is often the most important.
15The Value Functional: Theory
This chapter presents the theory behind the novel value functional method.
This includes the importance of the definition of the firm introduced in
this book, which includes separation, replicable business practices, and an
objective of the firm that is not restricted to profit maximization, the
maximization of value, rather than profit, a whirlwind introduction to
control theory, and the distinction between the familiar concept of a
function and the obscure notion of a functional. The author then presents a
functional equation (or Bellman equation) that relates the value of a firm
to specific optimization by the manager or entrepreneur. This theory is the
basis for the tenth approach to valuation described in this book: the
"recursive" or "value functional" approach. The author concludes by
proposing conditions for the existence of a solution to the value
functional equation for actual firms, basing these in human transversality
conditions that he outlines.
16The Value Functional: Applications
This chapter demonstrates practical uses of the value functional approach
in the estimation of the value of operating businesses. It includes a
detailed discussion of state and control variables, a presentation of four
different ways to formulate and solve a value functional problem, including
dynamic programming (also called "stochastic control"), Markov Decision
Problem ("MDP"), Hamilton-Jacobi-Bellman ("HJB") method, and "by hand." The
author also presents computational designs for these methods, and
observations on the practical difficulties of using them. Finally, the
author demonstrates the use of this approach on three actual companies.
This allows the reader to see the difference in results (and of the
necessity for subjective adjustments) among the value functional and other
valuation methods described in this book.
17Applications: Finance &Valuation
The author argues that start-up firms, distressed firms, and near-bankrupt
firms are the exception, not the rule, in the modern economy. This raises
the question of whether such firms, which are commonly small and financed
largely by the entrepreneurs involved, have value. The chapter also
discusses the applicability of traditional valuation methods for such
firms, compared with the novel value functional or recursive method. The
author concludes that, when properly evaluated, start-ups and distressed
firms do have value.
18Applications: Law & Economics
This chapter demonstrates applications of the value functional or recursive
approach to topics in law and economics, including the effects of
government policy on business decisions, and the estimation of economic
damages incurred due to breaches of contracts. The effect of uncertainty in
future government policies on private sector hiring decisions is one topic
for which the value functional method provides an insight that is lacking
in the standard neoclassical model. The author presents a model in which
managers maximize value, rather than maximize profit. In such a model,
businesses may rationally reduce current hiring due to the risk of policies
that would impose higher costs in the future. The value functional approach
also provides powerful methods to estimate commercial damages in breaches
of contract involving intellectual property, new businesses, the ability to
open or expand operations, and other situations commonly arising in
business.