Published research has overstated the size premium, says ‘Firm Size and Stock Returns: A Quantitative Survey,’ a new analysis conducted by Anton Astakhov, Tomas Havranek, and Jiri Novak from the Institute of Economic Studies at Charles University in Prague. The article appears in the Journal of Economic Surveys.

Astakhov, Havranek, and Novak collected estimates of the effect of size on stock returns reported in 102 published studies and synthesised the often-conflicting results. Their ‘meta-analysis’ concludes that published research initially showed a significant size premium but that the bias declined as newer research had different findings. Specifically, the study found a drop of about 50% in the magnitude of the size premium in studies using data after 1981 compared to studies with earlier data. That year is considered a turning point after Rolf Banz identified the small stock premium, and many analysts believe that the new research led many investors to adjust their portfolios, thereby diminishing the differences in experienced market returns Banz had identified.

‘Our findings support the proposition that the magnitude of the size premium varies over time (Horowitz et al., 2000a; van Dijk, 2011) and more specifically that it has decreased after [the] 1980s,’ the researchers conclude.

BVWire—UK notes that other studies suggest price multiples of smaller private firms are lower than multiples of larger private firms, which may be evidence that a size premium still exists in private firms. Often, illiquidity and inefficient markets for private firms, rather than size, are the real reason that a small enterprise may be worth less than a larger one. This new study agrees that size may still affect private-company returns, but the authors say their meta-analysis restricted most of the extra risk to the very smallest segments of the private markets.

Further, using public market data as a proxy for estimating private-company risk and performance will always be problematic. The researchers note a strange anomaly, for instance, that the size premiums remain large since the 1980s—if you only consider returns data from the month of January for each year (no one appears to understand the bases for this statistical pattern).

And most of the past studies included here, many conducted by some of the leading scholars of finance theory, focus on North American market data. Past studies that include LSE or other European returns information continue to show slightly larger size premia than returns for companies listed on NYSE or Nasdaq.

Even more confounding is this finding from the new meta-study:

[T]he size premium is positive when there is a general tendency of stock prices to decrease (i.e. in the ‘down markets’ or the ‘bear markets’), whereas it is close to zero when the stock prices have a tendency to rise (i.e. in the ‘up markets’ or the ‘bull markets’; Hur et al. 2014). This seems to be contrary to the notion of systematic risk, which predicts low returns on riskier assets in times of economic downturn when scarcity of income increases.

The debate within the business valuation profession (and the audit community) regarding the size premium in stock returns has raged for years, with no consensus over its magnitude or stability—or even existence. Yet, this first meta-analysis of the size premium provides an estimate that is smaller than what many people believe.

In collaboration with RICS and IVSC, the iiBV have released their Valuing Financial Instruments video webinar earlier this month. The panel includes Justin Burchett (managing director, Stout New York); Srividya Gopalakrishnan (managing director and Southeast Asia leader, Duff & Phelps, Singapore); Kumar Dasgupta (technical director of Financial Instruments, IVSC London); and Nicolas Burdeau (partner, Deloitte, Paris). It’s moderated by Michael Badham, iiBV executive director.

Meanwhile, IVSC’s recently appointed Financial Instruments Standards Board has published an Agenda Consultation. The board has received some input but is still seeking feedback regarding the approach the board should take and the prioritisation of their work. You can download the consultation paper here.

No effective set of international valuation practice standards for financial instruments have yet been generally adopted. Even a common definition of the term ‘complex financial instruments’ is elusive. This has resulted in both inconsistent and sometimes low-quality valuation practices.

Beyond RICS and IVSC, financial regulators and others in the UK and abroad have expressed concern about the quality and consistency of financial instrument valuation practice. For instance, earlier this summer, the U.S. PCAOB released their own ‘Auditing the Fair Value of Financial Instruments.’

Most of the analysis of the IASB’s IFRS 16 rule on lease accounting, which went into effect in January 2019, has been from the audit and accounting side. The impact on both real property and business valuators is often overlooked. None of the international business valuation standards offer guidance for practitioners in this area yet. Still, for certain entities, IFRS 16 could require additional analysis and changed methodologies. Valuers who’ve discussed the rule’s impact on business valuations mention these changes, for instance:

• The discount rate may be different depending on whether the right to use is a positive compared to market values or a negative. The difference occurs because one value is secured and the other may not be.

• Implementation of the new standard is in process, so comps from CapIQ or Bloomberg may not be apples to apples. This makes it much more difficult to apply market approaches to lease asset calculations.

• Right to use calculations need to account for special terms such as renewal provisions and contingent payouts—it’s not just a calculation of whether leases are above or below market.

• Some real estate appraisers believe they’re seeing companies change their market behaviour by signing shorter leases to avoid balance sheet impacts. There’s some concern that this could create new risks to future cash flows, particularly for businesses such as retail where sales are related to space resources.

Separately identifiable intangibles are making up a bigger portion of the purchase price allocations for the big deals in the media sector, though practices vary widely, reports Grant Thornton in their new ‘What’s Been Happening in Media M&A’ white paper. The result is a slight drop in median goodwill placed on the balance sheet (the current average is now 57% of intangible assets, with customer relationships growing particularly for content companies). Other commonly reported intangibles (as required under IFRS 3) include:

• Brands;

• Software/technology; and

• Content/libraries.

Two of the UK ‘mega-deals’ leading the 214 transactions included in the new report (Informa/UBM and Cineworld/Regal) had unique valuation characteristics so Grant Thornton notes them separately in their analysis, said study author Mike Thornton. ‘There is still a very wide array of how companies have allocated purchase price for their deals,’ Thornton concludes.

Other major acquirers include RELX, Next Fifteen, and Keyword Studios.

The Advisory Forum Working Group (AFWG) of the International Valuation Standards Council has launched a survey to identify the most common differences between business valuation for reporting purposes around the world and potential difficulties for achieving consistency with IVS, the global standards. The responses will be anonymous and will be grouped into key segments such as report writing, report disclosures, report content, valuation conclusion, and others. We will present the results in a future issue.

The top half-dozen firms handle a large portion of business valuation work in the UK, so anyone interested in the profession might note with interest the trend for the larger audit firms to provide software as well as services. Evidence of this trend includes the announcement last week that Moody’s Corp. acquired ABS Suite from Deloitte. Issuers and trustees use ABS Suite for the administration of asset-backed and mortgage-backed securities programs. It’s a small transaction for Moody’s, the approximately £4 billion company with thousands of UK-based employees—the company says the acquisition ‘strengthens their position as a provider of structured finance solutions’ but will not change their 2019 financial position materially.

‘Some jurisdictions have acted unilaterally, some have made failed attempts, while some have adopted a “wait and see” approach,’ the current issue of Bloomberg BNA’s Transfer Pricing Forum says.

While the handful of big audit firms primarily conduct business valuation for international tax practice, many valuers in the UK, even those without multinational clients, are following the anticipated Organisation for Economic Co-operation and Development (OECD) harmonised global approach to the digitalisation of the economy.

The OECD issues transfer pricing guidelines that are voluntary for member nations. The free 96-page Transfer Pricing Forum document, which can be requested at the link above, has perspectives from practitioners in 23 countries, including the UK, China, Japan, Russia, Italy, India, Germany, France, the U.S, and others.

ACG UK Chapter Trends in Alternative Capital, 15 October, London

ICAEW Excel Modelling—Investment Appraisal, Valuation and Business Cases, 18 October or 15 November, London

ICAEW Annual Business Valuation Conference—23 October, London

ICAS New April 2019 Corporate Insolvency Rules for Scotland course, 31 October, Glasgow; 1 November, Aberdeen; 7 November, Edinburgh; 15 November, Perth

ICAEW Forensic and Expert Witness Conference, 7 November, London

UK200 Group Annual Conference, 13-15 November, Liverpool

ICAEW Practical Business Valuation, 11 and 25 November, London

Our thanks to Andrew Strickland and Marianne Tissier for their valuable contributions to BVWire—UK.

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