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 Law 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.