In teaching valuation, we found that students generally lacked the detailed knowledge required to value a company. Although other finance textbooks cover these topics, they do so at a fairly low level of detail and generally do not cover the relevant finance and accounting complexities required to perform valuations. As such, students who use these textbooks typically struggle in the workplace because they either lack the requisite knowledge or fail to understand how to integrate the accounting information with the appropriate finance theory. We integrate the relevant accounting topics with the appropriate finance theory, and demonstrate, using step-by-step examples, how to implement the valuation frameworks we discuss. The book is organized so that instructors can choose not to assign certain chapters or sections of chapters and omit some of these details. In addition, we incorporate relevant empirical evidence and theory from prior studies as well as our own work.
corporate valuation holthausen pdf 20
The book consists of six parts. Part I (Chapters 1 through 4) presents an overview of valuation issues and topics, how valuation is used in practice, and the basic tools needed to value a company. These tools include analyzing financial statements, measuring performance, understanding and measuring cash flows, and creating a financial model. Part II (Chapters 5 through 7) discusses the discounted cash flow (DCF) valuation model, including the residual income valuation model.
This part of the book demonstrates the equivalence of the alternative forms of the DCF valuation model and when each of the forms is more appropriate to use. Part III (Chapters 8 through 11) discusses how to measure the equity, unlevered, debt, weighted average, and other costs of capital used in the valuation. Part IV (Chapter 12) discusses how to value and measure the costof capital for warrants, options, and other equity-linked securities. Part V (Chapters 13 and 14) discusses the conceptual framework and practical application of the market multiple valuation method. Finally, Part VI (Chapters 15 through 17) applies and extends these valuation frameworks to specific settings such as highly leveraged transactions, mergers and acquisitions, and cross-border valuations.
In Chapter 1, we provide a top-level overview of the steps in a valuation process used to value a company. These overview steps include analyzing the competitive landscape, analyzing the company and its potential competitive advantage, creating a financial model, measuring the costs of capital, market multiple valuation, and alternative valuation approaches. In the relevant subsequent chapters, we provide detailed steps for each of these overview steps discussed in Chapter 1. For example, in Chapter 4 we provide a detailed step-by-step process for developing a financial model. These step-by-step process guides are included in many subsequent chapters. We show an example of this step-by-step process from Exhibit 15.8 for leveraged buyout transactions.
The understanding of valuation and how it plays a role in business decisions is essential to the success of any business and its decision makers. Throughout each chapter, we include real company data and examples to engage students and provide an understanding of how the theory and conceptual frameworks are used in practice. Each chapter contains excerpts and summaries from company financial statements, SEC filings, and new articles illustrating how the topics in the chapter apply to real companies using the Valuation in Practice notes as well as an opening vignette. In addition, each chapter contains one or more detailed examples demonstrating a step-by-step application of the theory and conceptual frameworks discussed in the chapter, which provide an important bridge to help students understand how to apply the concepts. Many of these detailed examples use information from real companies; for example, we use the Xerox Corporation and Affiliated Computer Services, Inc. merger to demonstrate a step-by-step application of the concepts discussed in Chapter 16 on mergers and acquisitions (Exhibit 16.26 is an example of an exhibit detailing a valuation in the context of a real-world acquisition).
Professor Holthausen is widely published in both finance and accounting journals. His research has studied the effects of management compensation and governance structures on firm performance, the effects of information on volume and prices, corporate restructuring and valuation, the effects of large block sales on common stock prices, and numerous other topics. His research has appeared in such journals as the Journal of Accounting and Economics, The Accounting Review, the Journal of Accounting Research, the Journal of Finance and the Journal of Financial Economics. He has served in various editorial capacities for all five journals listed above; either as consulting editor, associate editor, editorial board member or reviewer. He is currently an editor of the Journal of Accounting and Economics.
Professor Holthausen has consulted with a variety of companies. His specific consulting engagements are varied and include such diverse activities as serving as a compensation consultant to a Fortune 500 Company, consulting with an investment company in the development of fundamental trading rules used to manage equity portfolios and performing valuation analysis in a variety of situations.
Professor Zmijewski's research focuses on the valuation of the firm and its parts, as well as the ways in which various capital market participants use information to value securities. He has published various articles in academic journals such as the Journal of Accounting Research and the Journal of Accounting and Economics, and won the American Accounting Association's Competitive Manuscript Award (1984). He has been an Associate editor of The Accounting Review and on the editorial Boards of both the Journal of Accounting Research and The Accounting Review. In addition to his faculty duties at the University of Chicago, Professor Zmijewski also held the positions of Deputy Dean, Ph.D. Program faculty director, and the Center for Research in Security Prices faculty director. He teaches courses in valuation, mergers and acquisitions, financial analysis, accounting, and entrepreneurship and has won teaching awards for his teaching in both the M.B.A. and executive M.B.A. programs at Booth.
Thus, we focus on accounting-based earnings quality measures, inspired by Francis et al. (2004), and we do not restrict the sample to specific industries, periods, circumstances, or items. We review archival-based studies for reasons of comparability, which appears to be the most dominant methodology among earnings quality studies. We further contribute to previous research because we explicitly show whether corporate governance, such as board characteristics, influences potential fair value-related earnings management. We hold the incorporation of corporate governance as essential for three reasons. First, corporate governance mechanisms are a tool to mitigate opportunistic behavior (Shleifer and Vishny 1997). Second, corporate governance research may guide future regulatory efforts that have gained attention over the last decades (e.g. Obermann 2020; Kovermann and Velte 2019; Gerum et al. 2018). Third, research history shows that two research fields, corporate governance research and accounting research, converge and several accounting topics cannot be interpreted appropriately without considering corporate governance implications (Brown et al. 2011; Armstrong et al. 2010).
Our literature review is structured as follows. Section 2 briefly describes the neoclassical principal-agent theory as the dominant theoretical framework and emphasizes signalling issues. Section 3 explains the selection of the reviewed studies (Sect. 3.1) and illustrates earnings quality (Sect. 3.2.1) and corporate governance measures (Sect. 3.2.2). Section 4 summarizes the reviewed articles, and Sect. 5 shows the limitations of the current research and gives recommendations to expand future research.
In the context of these agency risks, corporate governance serves to mitigate agency conflicts (Shleifer and Vishny 1997). According to Jain and Jamali (2016), we partition (corporate) governance mechanisms into four levels: (1) institutional relates to the environment rather than the organisation directly, (2) firm (e.g. ownership structure), (3) group (e.g. board structure and compensation), and (4) individual (e.g. CEO characteristics). We add external auditors to firm level corporate governance mechanisms, who face a particular role in agency conflicts because they assure the reasonableness of fair value measurements (ISA 540).
According to our theoretical framework, managers can exploit discretion in fair value measurements, either adversely or beneficially, and corporate governance may affect this behavior. To shed some light on these theoretical considerations and to structure previous evidence, we analyze related empirical findings via a structured literature review, inspired by Massaro et al. (2016).Footnote 2 The data selection is based on the term fair value in connection with six (groups of) keywords for obtaining an objectified sample. We used the terms discretion to refer to the origin of managerial behavior and earnings management to refer to managerial behavior that can be explained by adverse or beneficial earnings management. Furthermore, we used the term corporate governance to refer to mechanisms that affect managerial behavior. We also used the terms audit, auditing, and auditor to refer to auditing issues as a specific set of corporate governance.
Through our search metrics and standardized selection of studies, we obtained a sample of 162 potentially relevant articles that cover discretion, earnings management, and corporate governance (including auditing) topics in connection with fair value accounting. This procedure enabled us to select an empirical framework objectively that best fits the investigation of earnings management in fair value accounting and shows how corporate governance influences this relation. We selected earnings quality research designs because they represent the most prominent setting in which to investigate earnings management (e.g. Burgstahler and Dichev 1997; Healy and Wahlen 1999; Dechow et al. 2010a).Footnote 4 In order to obtain comparable results, we focus on archival-based studies, which appear to be the most dominant methodology among earnings quality studies. We differentiate between two groups of earnings quality measuresFootnote 5: accounting-based and market-based (Francis et al. 2004). While accounting-based measures solely investigate accounting information, market-based measures incorporate market prices and returns of firms, that is, market assessments. Examples for the letter are value relevance (Barth et al. 2001; Holthausen and Watts 2001; Beatty and Liao 2014) and conditional conservatism (Kim et al. 2013; Badia et al. 2017; Black et al. 2018). 2ff7e9595c
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