Empirical Comparison of Income-Based Valuation and Market Capitalization

In the November issue of “BewertungsPraktiker”, Martin Weimann published an empirical study on the relation between the market capitalization and the intrinsic value of publicly listed corporations and their stocks.  Under German regulations, the stock value derived from the market capitalization is under usual condition used as a minimum amount for the expropriation of their stocks, as the shareholders lose the option to disinvest on the open market.   It is not unusual, though, that a higher compensation is paid based on an intrinsically value – the objectified business value.  Based on the efficient market hypothesis, it could be assumed that with perfect information of the market participants, the market capitalization should reflect the intrinsic value of the enterprise and therefore suffice as an appropriate compensation for the minority shareholders.  Weimann examines publicly available information on over 500 such restructuring procedures to scrutinize this assumption empirically.  He uses as reference period the time from January 2002 through March 2020, thus cutting off before the effects of the Covid-pandemic were visible on the market.  Out of the 579 German restructuring procedures over this period for which information was available, 311 also considered the market capitalization.  In 45% of these cases, the annual meeting made an offer to the minority shareholder based on the market capitalization, while in 55% a higher compensation was offered based on the intrinsic value.  These alone resulted in higher compensations of about 800 million euro.  For these 311 cases, the appraisal proceeding increased the proportion of the intrinsic value-based compensation 77% or total compensations that were about 1.6 billion euro higher than the market capitalization.  In 188 cases, a formal squeeze-out proceeding followed, where the annual meeting offered in 62% a compensation above the free float and the court decided in 77% of cases on such.  Here, the total compensation in excess of the free float was about 220 million euro for the offer of the annual meeting and 560 million euro according to the court decision.  The author concludes that the difference in the information base prevents the market capitalization and the intrinsic value from being equal.  While the quoted stock price is based on publicly available information such as from the annual reports and public statements, the intrinsic value also considers non-public information, especially the detailed business plan.

In our experience, intra-group transfers of publicly quoted stocks are rare and exceptional cases.  Nonetheless, in our view the article still provides some helpful general information for transfer pricing practitioners by illustrating the importance of information available for the different parties when assessing the value-estimates of transaction parties and thereby the likely arm’s-length price.  Uncontrolled market participants will typically endeavor to obtain all relevant information for their business decisions.  For controlled transactions it is typically difficult to judge, to which this would be possible in a hypothetical arm’s-length situation.  For this case, the German regulations explicitly require the assumption that both parties would be pricy to the relevant information.  Nonetheless, international guidelines – especially the OECD Guidelines – are less clear on this question.  Especially in cases of business valuations that are performed in connection with intra-group restructurings, the practitioner has to address this issue in advance and in a robust manner, before the international practice and regulations achieve a higher degree of consistency. The article by Dr. Martin Weimann is published in the November 2020 issue of “BewertungsPraktiker” on pages 113 through 117.

Australian Financial Guidelines

On 10 December 2020, the Australian Tax Office (“ATO”) updated its practical compliance guideline PCG 2017/4 “ATO compliance approach to taxation issues associated with cross-border related party financing arrangements and related transactions” (“Financing Guidelines”).  These guidelines outline the TP risk-assessment for financing transactions and are supposed to help the taxpayer in cooperating with the ATO.   This update consists in the final version of Schedule 3, which specifically addresses interest-free loans between an Australian taxpayer and its foreign related parties.  The schedule sets the default assumption that such arrangements are of very high TP risk and provides an approach to evidence if the arrangement is either arm’s-length, essentially an equity contribution, or that unrelated parties would in similar circumstances had engaged in an equity contribution instead of a loan.  Where such evidence can be provided, the taxpayer can reduce the risk rating accordingly.

The ATOs Financing Guidelines can be accessed online here: https://www.ato.gov.au/law/view/document?DocID=COG%2FPCG20174%2FNAT%2FATO%2F00001