Discount for the Lack of Control Definition
A Discount for Lack of Control is a fixed amount or percentage deducted from the selling price of a block of shares. The amount is deducted from the share value because that block of shares lacks some or all powers of control in the firm.
A Little More on What is Stock Discount for Lack of Company Control
The minority shareholders usually do not have the authority to make decisions regarding the company’s strategies and operations. They also may not have the power to influence the election of the directors. They may even lack the control over the sales of their own shares or its return. All these disadvantages attached to the minority share reduces the value of minority equity shares against the total valuation of the company.
Example of Discount for Lack of Control
For example, a company has two shareholders owning 60% and 40% each. If the total equity value of the company’s share is $ 2,00,0000, the 40% would be $80,0000. But the buyer acquiring 40% won’t agree to pay that much for the minority share because it lacks the power of control.
References for Lack of Control
Discount for the Lack of Control
Estimation of the discount associated with the transfer of restricted securities, Trout, R. R. (1977). Taxes, 55, 381.
Diversification discount or premium? New evidence from the business information tracking series, Villalonga, B. (2004). The Journal of Finance, 59(2), 479-506. This paper uses the Business Information Tracking Series (BITS), a new census database that covers the whole U.S. economy at the establishment level, to examine whether the finding of a diversification discount is an artifact of segment data. Using these data on a sample that yields a discount according to segment data, the paper finds a diversification premium. The premium is robust to variations in the sample, business unit definition, and measures of excess value and diversification.
The private company discount, Koeplin, J., Sarin, A., & Shapiro, A. C. (2000). Journal of Applied Corporate Finance, 12(4), 94-101. This paper shows that when appraisers or investment bankers value a private company by reference to an otherwise similar but public company, they typically apply a discount. The paper explores difefrent recent debates om the estimation of such discounts. The paper present an alternative framework to estimate this discount. It computes four valuation multiples for a set of private transactions and a comparable set of public transactions.The paper finds that for both the domestic transactions and foreign transactions, the discount for earnings multiples is statistically and economically significant.
The Diversification Discount Puzzle: Evidence for a Transaction‐Cost Resolution, Aggarwal, R., & Zhao, S. (2009). Financial review, 44(1), 113-135. This paper suggests that the literature on the corporate diversification discount and the relative efficiency of internal versus external capital markets provides mixed results. The paper argues that transaction‐cost economics is useful in understanding this puzzle.
Valuation of Closely Held Partnerships and Corporations: Recent Developments Concerning Minority Interest and Lack of Marketability Discounts, Harris, J. E. (1989). Ark L. Rev., 42, 649.
Liquidity and asset prices, Amihud, Y., Mendelson, H., & Pedersen, L. H. (2006). Foundations and Trends® in Finance, 1(4), 269-364. This paper portrays the liquidity of traded assets as an important attribute which is often ignored in financial management theory. The paper suggests that firms can benefit from policies that increase the liquidity of the claims they issue. However, enhancing the liquidity of traded assets entails nontrivial costs. The associated tradeoff is then examined and a number of commonly observed corporate financial policies and institutional arrangements are explained as liquidity-increasing investments.
The discount for lack of marketability in privately owned companies: a multiples approach, Paglia, J. K., & Harjoto, M. (2010). Journal of Business Valuation and Economic Loss Analysis, 5(1). This study investigates a valuation adjustment, known as the discount for lack of marketability (DLOM) for private firms. By matching private company transactions with publicly traded counterparts, the paper finds discounts that average 65-70% and exceed 80% in some sectors of the economy. These findings put into question the sizes of discounts typically applied in valuation engagements for privately-held companies.