Document Type

Working Paper

Publication Date

2018

Center/Program

Center for Law and Economic Studies

Center/Program

Richard Paul Richman Center for Business, Law, and Public Policy

Abstract

Prior scholarship points to disagreements about valuation and judicial valuation error as key drivers of Chapter 11 outcomes. Avoiding valuation disputes and valuation errors is also the underlying driver of most proposed reforms, from Baird’s auctions to Bebchuk’s options. In this paper, we undertake a detailed examination of bankruptcy court opinions involving valuation disputes. Our paper has two goals. The first is to understand how parties and their expert witnesses justify their opposing views to the judge, and how judges decide between them. The second is to provide practical guidance to judges in resolving valuation disputes. We document surprisingly pervasive (and often self-serving) errors in expert testimony. This is particularly true when valuation experts apply the discounted cash flow (DCF) method. The choice of discount rates is frequently unsupported by, and often at odds with, finance theory and evidence. Judges are frequently unable to recognize these problems. We propose simple strategies based in finance theory that judges can employ (such as avoiding the use of company-specific risk premia in discount rates) to reduce the scope for valuation disagreements in Chapter 11. We also recommend that judges rely on the peer reviewed finance and economics literature to assess the scientific reliability of discount rates.

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