The recent item “Grabowski draws conclusions from ERP arguments in the Global GT case” (BVWire™ #96-1) reported: “…the Court rejected the use of Ibbotson’s “historical” equity risk premium, and instead opted for a significantly lower “supply-side” equity risk premium.” However, Roger Grabowski (Duff and Phelps) clarified the matter, stating “the Court did not opt for Ibbotson’s supply side ERP.”
Ibbotson’s lower supply side ERP was merely one brick in the wall used by the Court (among many “bricks”) to build a case against using the historical ERP, but the Ibbotson supply side ERP was not the ERP ultimately chosen by the Court. The ERP chosen by the court was the petitioner’s expert’s 6.0% estimate, which the Court based on many different things, including the SS ERP, ERP estimates based on historical data over longer time periods than Ibbotson, recent valuation research, and surveys. The fact that the lower ERP the Court settled on was similar to the lower SS ERP was coincidental only.”
The Court cited recent research, (including Pratt/Grabowski) (from the Client Alert, see below):
“…wealth of recent academic and professional writings that supports a lower ERP estimate…” that were put forth in the hearing. The Court went on to say that the “…relevant professional community has mined additional data and pondered the reliability of past practice and come, by a healthy weight of reasoned opinion, to believe that a different practice should become the norm...”
The Court also cited surveys:
“…also cites to a survey of finance professors, which found that the mean ERP taught by 369 professors is 5.96%, and a report of JP Morgan estimating the ERP to be in the range of 5% to 7%. Although the surveys cited by (petitioners’ expert) are not so compelling as to be conclusive, they suggest that current academic thinking puts the ERP closer to 6.0% than to 7.1%.”
The Court also cited other more long-term studies:
“If one is going to use an approach that simply involves taking into account historical equity returns, then one has to consider that very well-respected scholars have made estimates in peer-reviewed studies of long-term equity returns for periods much longer than Ibbotson, and have come to an estimate of the ERP that is closer to the supply side rate Ibbotson himself now publishes as a reliable ERP for use in a DCF valuation…”
Grabowski has offered Duff & Phelps’ Client Alert: “Delaware Chancery Court Fails to Adopt the Morningstar/Ibbotson Historical Equity Risk Premium (ERP)” to BVWire readers via BVR’s free downloads section here.
Please let us know
if you have any comments about this article or enhancements you would like to see.