“There has been no size premium for the past 40 years,” said Professor Aswath Damodaran (New York University Stern School of Business), who has been called the “Dean of Valuation.” This was in response to an audience question during his keynote address at the recent CBV Institute Congress 2021.
Two camps: This is not a new remark by Damodaran—he has been saying this for years (see his 2015 post here). He is referring to ongoing academic research that concludes that the size effect has diminished or disappeared since it was first documented in 1981 (recent paper here). But the vast majority of valuation practitioners believe that the size premium exists. During a BVR webinar, a poll of the audience (of about 200 attendees) found that 94% of them use a size premium.
If the academic community says that the size effect disappeared long ago, why do valuation practitioners continue to embrace it? As Damodaran points out, one reason is the time horizon of historical returns. If you look at the last 40 years, the size effect is very different than if you go all the way back to the 1920s. You can clearly see this difference in the Cost of Capital Professional platform, which gives you control over the time horizon of historical return data that are appropriate for your subject entity. That is, professional judgment is required in choosing the part of history you believe best represents investor expectations of the future.
Damodaran points to another reason for clinging to the size effect, which is simply this: It’s easier to defend something everyone else is doing.
He also notes that the market does not seem to buy into the size effect. “After all, if the proponents of small cap premiums are right, bundling together small companies into a larger company should instantly generate a bonus, since you are replacing the much higher required returns of smaller companies with the lower expected return of a larger one. In fact, small companies should disappear from the market.”
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