In Practice The Value of Control

The notion that control is worth 15% or 20% or some fixed percent of every firm's value is deeply embedded in valuation practice and it is not true. The value of control is the difference between two values - the value of the firm run by its existing management (status quo) and the value of the same firm run optimally. Value of control = Optimal value for firm - Status quo value

Thus, a firm that takes poor investments and funds them with a sub-optimal mix of debt and equity will be worth more if it takes better investments and funds them with the right mix of debt and equity. In general, the worse managed a firm is the greater the value of control. This view of the world has wide ramifications in corporate finance and valuation: - In a hostile acquisition, which is usually motivated by the desire to change the way that a firm is run, you should be willing to pay a premium that at best is equal to the

36 You may wonder why the dollar debt does not change even though the firm is moving to a 30% debt raito. In reality, it will increase but the number of shares will decrease when Disney recapitalizes. The net effect is that the value per share will be close to our estimated value.

value of control. You would rather pay less, to preserve some of the benefits for yourself (rather than give them to target company stockholders). - In companies with voting and non-voting shares, the difference in value should be a function of the value of control. If the value of control is high and there is a high likelihood of control changing, the value of the voting shares will increase relative to non-voting shares.

In the Disney valuation above, the value of control can be estimated by comparing the value of Disney, run optimally, with the status quo valuation done earlier in the chapter. Value of controlDisney = Optimal value - Status quo value = $30.45 - $11.14 = $19.31 The fact that Disney trades at $26.91 can be an indication that the market thinks that there will be significant changes in the way the firm is run in the near future, though it is unclear whether these changes will occur voluntarily or through hostile actions.

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