Damodaran tosses some dynamite during BVR webinar
Historical equity risk premium? “I don’t like a backward-looking and stagnant premium.” A “normalized” risk-free rate? “Don’t use it.” The size premium? “Fiction!” Company-specific risk premium? “[expletive deleted]!!” Never one to mince words, Aswath Damodaran (New York University Stern School of Business) aired his strong views in response to questions from the audience during a recent BVR webinar. His opinions are always thought-provoking, and he gave some solid advice on valuing companies amid inflation.
Inflation and valuation: The webinar title was “In Search of a Steady State: Inflation, Interest Rates, and Value; The (Inflation) Genie Escapes the Bottle!” He’s done a number of lectures on this, but we asked him to focus on the practical aspects of how valuation experts should assess the impacts of inflation when valuing a private company. Damodaran pointed out that there are disparate effects of inflation, and the value of some companies will be unaffected, others will be negatively affected (to varying degrees), and a few may actually benefit from inflation.
He advised experts to go “back to fundamentals” and examine six basic variables when determining how sensitive your subject company is to inflation. One variable is “pricing power,” which is the ability of companies to pass inflation on to customers. Of course, the more power a company has that enables it to pass price increases on to customers, the more protected it would be from inflation. The other variables are cost structure (margins), investment efficiency, cost of equity, cost of debt, and what he terms “failure risk,” which is a separate variable not reflected in cash flows nor the discount rate.
A full recap of the webinar will be in the August issue of Business Valuation Update.
FASB hits ‘pause’ on goodwill project
The big news at the 2022 ASA NY Fair Value Conference last week was that the FASB has dropped its project on goodwill, but it could be revisited in the future. “The goodwill project has been removed from the active agenda,” Joy Sy, a supervising project manager at the FASB, told conference attendees. That means it will not be seeking any more stakeholder feedback on the matter but will monitor developments on this matter, including a project on goodwill disclosures at the International Accounting Standards Board.
For the past four years, the FASB considered whether annual goodwill impairment tests should be done away with for public companies in favor of a new model that would include amortization. For the most part, the valuation community believed that, from a user perspective, the benefits of the transparency and information the current impairment model provides outweigh the costs. The cost-benefit issue was one of the factors that triggered the FASB to take on the project in the first place. Also, the CFA Institute (CFAI) expressed serious concerns about the possible reversion back to amortization.
May be back: But the FASB will not simply “throw it out,” said Richard Jones, FASB chair, during its June 15 meeting that decided the project’s fate. “To the extent that it becomes relevant in a future period, it is certainly something we can look at,” he said. During the meeting, FASB board members said they did not think the current impairment-only model is a good reflection of goodwill and they believe it needs improvement. This time around, there just wasn’t enough of a case made for the change, which would have been significant. But the project will not disappear, and “we may be able to bring it back again one day,” said Jones.
Also, there’s an ongoing intangibles project at the FASB that remains “active,” said Tanya Paul, a post-doctoral fellow at the FASB who gave an update on that project at the ASA conference. Under that project, potential improvements are being considered for items including accounting and disclosure of intangibles, including software costs, internally developed intangibles, and research and development.
We’ll have more takeaways from the ASA Fair Value Conference in next week’s BVWire.
Bankruptcy court “Knocks Out” transfers from ‘personal piggy bank’
In a bankruptcy case in Illinois, the three tests for insolvency came into play when a dispute arose as to whether transfers the debtor company made totaling $1.72 million were fraudulent. The key issue in matters of fraudulent transfers is whether the debtor was solvent when it made the transfer (or would remain solvent as a result of the transfer). The three solvency tests (under Section 548 of the Bankruptcy Code) are: (1) the balance sheet test (do assets exceed liabilities?); (2) the cash flow test (can the company pay off debts as they come due?); and (3) the capital adequacy test (does the company have enough capital to operate?). If the debtor fails any one of the tests, it is an indication of a fraudulent transfer.
In this case, while the debtor passed the balance sheet test, it failed the other tests, the court found. Also, the court concluded that the company “received no value in exchange” for the transfers, noting that they were made not to satisfy company debts, but rather for the benefit of the controlling shareholder, who used the company as his “personal piggy bank.” Therefore, the transfers are fraudulent and must be refunded to the bankruptcy estate.
The case is Stone v. Citizens Equity First Credit Union (In re Int’l Supply Co.), 2022 Bankr. LEXIS 865; 2022 WL 962296, and a case analysis and full opinion are available on the BVLaw platform.
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Recordings available of free webinar series from the IVSC
Kroll has been sponsoring a series of webinars presented by the International Valuation Standards Council (IVSC) that started June 2 and runs through June 27. Recordings are available for the past programs if you click here. The next program will be on June 27, The Evolution of ESG in Valuation. Past webinars in the series covered topics including the global economic outlook, the impact of inflation on valuation and the cost of capital, and the growing influence of digital assets in the investment world. Speakers include IVSC chair and former UK Chancellor of the Exchequer, Alistair Darling; Kroll chief economist and Financial Times columnist, Megan Greene; IMF Global Markets chief and former IOSCO deputy chair, Ranjit Singh; Corporate Reporting Users’ Forum (CRUF) chair, Jeremy Stuber; PwC global asset and wealth management leader, Olwyn Alexander; UCLA emeritus professor of finance, Bradford Cornell; and many others.
Preview of the July 2022 issue of Business Valuation Update
Here’s what you’ll see:
The International Association of Certified Valuation Specialists