BVWire Issue #157-1 | October 7, 2015


Black-Scholes model can overvalue certain ESOs and other options

The Black-Scholes model (BSM), a common formula used to value employee stock options (ESOs) and other options, may overvalue those with long holding periods, says Martin Greene (Greene Valuation Advisors LLC).

Trouble source: In an upcoming article in Business Valuation Update, Greene says a limitation of the BSM is that it does not test distribution properties of the underlying stock prices. “Without testing this underlying assumption that the underlying stock prices are  normally distributed, can it be certain the BSM is providing a reasonable conclusion?” he writes. When applying the BSM to shorter time periods for the exercise date, even for higher volatilities, the distributions remain sufficiently normal, he points out. “For longer holding periods, this will impact the model’s shape and integrity. Therefore, it appears that the BSM may not be appropriate for longer holding periods without modification.”

In the article, Greene uses a Monte Carlo simulation to demonstrate his point. He recommends that valuators should conduct an analysis of the underlying distribution assumptions of the BSM and an analysis of the conclusions prior to applying the model to valuing options.

The article will appear in the November issue of Business Valuation Update (subscription required).

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Damages expert stumbles over causation

Causation confounds even experienced valuators. A common mistake is not to address it at all and risk exclusion under Daubert. But a recent decision presents the opposite situation: an expert who made causation his be-all and end-all and improperly expanded the role of a damages expert.

Case turns on causation: After the plaintiff was terminated, he filed suit, claiming an employee of the defendant had made defamatory statements about him that eventually cost him his job. He pursued a host of damages, including loss of earnings and benefits and loss of economic relations. Whether and to what extent the alleged defamatory statements caused the plaintiff’s termination was a key issue in the case. The plaintiff retained an expert to calculate damages. The expert report said the damages determination was “based on an assumption of liability. I have done no work to determine liability and do not expect to do any such work.”

The defense offered a rebuttal expert, an experienced valuator, whose main objection seemed to be that the rivaling expert’s calculations were based on flawed assumptions. But he went further. Citing litigation practice guides, the rebuttal expert proposed that: (1) there were “two different contexts of causation, legal and economic”; (2) the issue of causation “continues to be expanded”; and (3) “an expert has a duty to understand and prove that a causal link exists between the incident and each of the damages elements.” As he saw it, “an expert is specifically precluded from relying upon an assumption that economic causation exists.” And “the consideration of all facts available in a case is critical to any economic loss analysis.” When opposing counsel asked him whether causation gave him “license to weigh and compare facts and reliability of witnesses,” he replied: “From an economic point of view, yes.” He added, “Expert witnesses are allowed to sit in the courtroom and listen to all of the testimony, because all of that has a bearing on causation, for example.” He concluded that “based on the economics and my review of the economics,” the plaintiff was terminated for reasons other than claimed.

Misconception: The plaintiff challenged the testimony under Daubert, arguing the expert’s opinions “invade the proper province of the jury to weigh the facts and evaluate witness credibility.” The court agreed. It said the rebuttal expert “twist[ed]” reference material into a concept the texts did not support, a “dichotomy between economic and legal causation that he attempts to exploit.” He “would elevate himself above the witnesses, attorneys, other experts, and even the jury in drawing conclusions.” His “misreading” of the cited authorities was “very troubling,” the court said, but his “serious misconception” of the role of an expert in the courtroom was “significantly more troubling.”

The court only admitted the portion of the opinion that critiqued the assumptions informing the plaintiff expert’s calculations.

Takeaway: According to the court, an expert “should understand causation and base his opinions on sound causation but is not to argue causation or prove it.”

Find a detailed discussion of Rowe v. DPI Specialty Foods, 2015 U.S. Dist. LEXIS 110605 (Aug. 19, 2015), in the November issue of Business Valuation Update; the court’s opinion will be available soon at BVLaw.

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Roundup of SECBA’s Atlanta conference

The Southeast Chapter of Business Appraisers held its annual valuation conference in Atlanta September 25-26. Gary Fodor, the chair of the SECBA, opened the conference and Bob Brackett, the secretary general of IACVA, the event co-sponsor, introduced IACVA, discussing the credential it offers, the benefits of membership, and current charter locations. BVR sponsored the CPE for the event.

Key takeaways: The conference opened with an economic update from Galina Alexeenko of the Atlanta Federal Reserve. Insights into the economic analysis of the Federal Reserve were interesting and provided the group with the most up-to-date outlook. Friday’s slate of speakers started out with a two-hour expert panel discussing common errors made by valuation practitioners. Brandi Ruffalo moderated the panel that included Brackett, Marcie D. Bour, and Frank Rosillo. One of the most common mistakes the experts see is a disconnect between analysis in the reports and the conclusions. The panel fielded questions and comments from the participants on practice tips and ways to reduce errors. Rosillo wrapped up the presentation discussing some of the methods that practitioners can use to avoid mistakes, which are highlighted in his new book, published by Wiley.

Dr. Mark Walker presented his research on corporate tax rates, delving into the history of corporate taxes and examining how public companies use various strategies to minimize taxes. He concluded with the average corporate tax rates actually paid.

Bour discussed fraud techniques used and how they can show up on financial statements. Using ZZZZ Best and Enron as two examples, she walked through how detailed analysis showed that things were not right. Careful analysis, including comparison to benchmarks in the industry, can be helpful in assessing whether companies may have issues.

Next week’s BVWire will have more takeaways from this very fine conference.

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Comments due soon on TAF control premium exposure draft

Attendees at this past Monday’s meeting held by The Appraisal Foundation in Washington, D.C., were reminded to submit comments on the exposure draft, The Measurement and Application of Market Participant Acquisition Premiums. Comments are due November 1, says Dayton Nordin (Ernst & Young), a member of the work group that developed the standard.

Other projects: Two other TAF standards projects are in the works: Valuation of Customer-Related Assets, which is “in the last stages of review” and should be issued by the end of this year, according to PJ Patel (Valuation Research Corp.), a member of the project’s work group. A third TAF work group is developing Contingent Consideration, which is still in the formative stage, Alok Mahajan (KPMG) told the audience.

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Healthcare services sector multiples

The S&P Healthcare Services Index has increased by 8.6% over the last three months, significantly outperforming the S&P 500 (a 6.4% increase over the same period), according to the September 2015 Healthcare Sector Update from Duff & Phelps. The best-performing sectors were healthcare staffing (up 26.4%), other services (up 19.1%), and emergency services (up 15.5%). The worst-performing sectors were assisted living (down 23%), psychiatric hospitals (down 17.2%), and diagnostic imaging (down 13.5%).

The current median LTM revenue and LTM EBITDA multiples for the healthcare services industry overall are 1.6x and 12.6x, respectively. The sectors with the highest valuation multiples include: HCIT (3.7x LTM revenue, 20.0x LTM EBITDA), healthcare REITs (12.8x LTM revenue, 16.4x LTM EBITDA), and emergency services (3.7x LTM revenue, 27.6x LTM EBITDA).

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Global BV news:

IVSC expected to start the revamping process

At the upcoming October 12 meeting in Paris of the International Valuation Standards Council (IVSC), the organization will likely adopt many of the recommendations of a special review group concerning a restructuring of the IVSC, according to Steven J. Sherman, chairman of the IVSC standards board. Sherman gave an IVSC update at the meeting of The Appraisal Foundation in Washington, D.C., earlier this week.

Reform needed: Last year, the IVSC commissioned an independent review group to do an assessment to ensure that the organization is equipped for the next phase of its development. The group focused on the governance, financial stability, processes, and output of the IVSC. In a Review Report, the group recognized the need for international valuation standards and that the IVSC is the most appropriate organization to develop them. However, the group concluded that “reform of the IVSC is needed if it is to fulfill its potential,” says the report.

The group makes specific recommendations, including taking steps to improve the organization’s financial long-term viability and its profile among key stakeholders. Also, the group urges the IVSC to review its staffing model and resources as well as establish a clearer definition of purpose and vision.

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BV movers . . .

People: Michael Maass joined the Madison, Wisc., firm Wegner as manager in the tax and business services department … Tim McPoland was elected managing director and chairman of the board of the Buffalo, N.Y., firm Freed Maick, succeeding Ronald Soluri as managing director and Robert Glaser as chairman of the board … Philip Ratliff joined Willamette Management Associates’ Atlanta office as a managing director and national director of Willamette Management Associates’ forensic analysis and litigation services practice … Harry Steinmetz joined the Manhattan office of Friedman as the partner-in-charge of New York Forensic, Litigation & Valuation Services (FLVS) … Vinay Torani and Joseph Mevorah have joined Navigant Consulting’s Financial Risk & Compliance segment in New York City to provide valuation and other advisory services to life sciences, healthcare, financial services, industrial products, technology, and telecommunication organizations … Lana Yelina was promoted to manager in the business assurance practice of the Marietta, Ga., firm Moore Colson.

Firms: Beckman & Kunkin of Scottsdale, Ariz., will merge with the South Dakota-based Eide Bailly on November 2 … Plante Moran was recognized as one of the “100 Best Workplaces for Women” by and Great Place to Work.

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CPE events

Why You Need to Use Local Market Rates for FMV in Physician Compensation and How to Calculate Them (October 8), with Mark O. Dietrich (Mark O. Dietrich, CPA, PC) and Timothy Smith (Ankura Consulting Group LLC). This is Part 5 of BVR's 2015 Special Series on Healthcare Valuation.

Valuing Full-Service Restaurants (October 15), with Lynton Kotzin (Kotzin Valuation Partners).

Valuing IP Using Apportionment Models (October 20), with Brian Buss (Nevium Intellectual Property Solutions). This is Part 7 of BVR's 2015 Special Series on Intellectual Property.

Case Studies in Purchase Price Allocations (October 22), with Nathan DiNatale (SC&H Group LLC).

Important note to webinar attendees: To ensure that you receive your dial-in instructions to BVR’s training events, please make sure to whitelist

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We welcome your feedback and comments. Contact the editor, Andy Dzamba at: or (503) 291-7963 ext. 133
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In this issue:

BSM caution

Causation woes

SECBA recap

TAF standards update

Healthcare multiples

Global BV news

BV movers

CPE events












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