Valuation Biases, Error Measures, and the Conglomerate Discount

Ingolf Dittmann and Ernst Maug
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Ernst Maug: Chair for Corporate Finance, University of Mannheim and Sonderforschungsbereich 504, Postal: L9, 1-2, 68131 Mannheim

No 07-37, Sonderforschungsbereich 504 Publications from Sonderforschungsbereich 504, Universität Mannheim, Sonderforschungsbereich 504, University of Mannheim

Abstract: We investigate biases of valuation methods and document that these depend largely on the choice of error measure (percentage vs. logarithmic errors) used to compare valuation procedures. We analyze four multiple valuation methods (averaging with the arithmetic mean, harmonic mean, median, and the geometric mean) and three present value approaches (dividend discount model, discounted cash flow model, residual income model). Percentage errors generate a positive bias for most multiples, and they imply that setting company values equal to their book values often becomes the best valuation method. Logarithmic errors avoid unwanted consequences and imply that the median and the geometric mean are unbiased while the arithmetic mean is biased upward as much as the harmonic mean is biased downward. The dividend discount model dominates the DCF-model only for percentage errors, while the opposite is true for logarithmic errors. The residual income model is optimal for both error measures.

Pages: 39 pages
Date: 2007-06-26
Note: Financial support from the Deutsche Forschungsgemeinschaft, SFB 504, at the University of Mannheim, is gratefully acknowledged.
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Related works:
Working Paper: Valuation biases, error measures, and the conglomerate discount (2007)
Working Paper: Valuation Biases, Error Measures, and the Conglomerate Discount (2006)
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