In a candid interview, Pablo Fernandez (University of Navarra), the author of a recent paper, “CAPM: An Absurd Model,” was asked why the model—which has also been criticized by others over the years—still has a prominent place in business schools and in valuation practice. “I did a survey eight or nine years ago of professors and asked them why they were still teaching the CAPM and beta,” he recalls. “They gave me two main reasons. First, the CAPM fills seven class sessions, so, they asked me, ‘What do we otherwise do in those seven classes?’ The other answer is that the students like recipes, so they keep teaching it.”
Lot of inertia: Fernandez believes the affinity for using recipes is partly the reason valuation practitioners continue to use the capital asset pricing model. “For consulting firms and regulators, there's also a lot of inertia and still enough of a mass of firms using it that you can justify its use by showing a list of all of those firms and people who still use it,” he says. “From the point of view of consulting firms, the beta impresses clients and people who are not in finance because it gives a sense of something magical and difficult going on. Also, it's very easy to copy the last valuation your company or colleague did when you are doing a new one, so that can perpetuate it.”
Fernandez talks about other valuation topics during the interview, conducted by Michael Crain (Financial Valuation Group), a valuation practitioner who has done academic research, most recently on the size premium. Read the complete interview in the July issue of Business Valuation Update (subscription required).
Please let us know
if you have any comments about this article or enhancements you would like to see.