Value of Control
When you divide the value of the equity by the number of shares outstanding, you assume that the shares all have the same voting rights. If different classes of shares have different voting rights, the value of equity per share has to reflect these differences, with the shares with more voting rights having higher value. Note, though, that the total value of equity is still unchanged. To illustrate, assume that the value of equity in a firm is $500 million and that 50 million shares are outstand-ing; 25 million of these shares have voting rights and 25 million do not. Furthermore, assume that the voting shares will have a value 10% higher than the on voting shares. To estimate the value per share:
Value per Nonvoting Share = $500 million / (25 million x 1.10 + 25 million) = $500 million / 52.5 million = $9.52 Value per Voting Share = $9.52 (1.10) = $10.48
The key issue that you face in valuation, then, is determining the discount to apply for nonvoting shares or, alternatively, the premium to attach to voting shares.
Voting Shares versus Nonvoting Shares
What premium should be assigned to the voting shares? You have two choices. One is to look at studies that empirically examine the size of the premium for voting rights and to assign this premium to all voting shares. Lease, McConnell, and Mikkelson (1983) examined 26 firms that had two classes of common stock outstanding, and they concluded that the voting shares traded at a premium relative to nonvoting shares. 9 The premium, on average, amounted to 5.44%, and the voting shares sold at a higher price in 88% of the months for which data were available.
The other choice is to be more discriminating and vary the premium depending on the firm. Voting rights have value because they give shareholders a say in the management of the firm. To the extent that voting shares can make a difference by removing incumbent management, forcing management to change policy, or selling to a hostile bidder in a takeover their price will reflect the possibility of a change in the way the firm is run.10 Nonvoting shareholders, on the other hand, do not participate in these decisions.
If the value of control arises from the capacity to change the way a firm is run, it should be a function of how well or badly the firm is run. If the firm is well run, the potential gain from restructuring is negligible, and the difference in values between voting and nonvoting shares should be negligible as well. If the firm is managed badly, the potential gain from restructuring is significant, and voting shares should sell at a significant premium over nonvoting shares.
One way to value control is to value the firm under existing management and policies and then revalue it, assuming that the firm is optimally run. The difference between the two values is the value of control:
Value of Control = Value of Firm Optimally Run Status Quo Valuation of Firm
The key to estimating this value is to come up with the parameters that you would use to value the firm, optimally run. This issue is revisited in Chapter 12, "Value Enhancement."
Control in Private Businesses
The issue of control also comes up when you are valuing private businesses, especially when the stake in the business that is being valued is less than a controlling one. For instance, a 49% stake in a private business may sell at a considerable discount on a 51% stake because the latter provides control whereas the former does not. You can estimate the discount, using the same approach that you developed for valuing control, by valuing the private business under the status quo and then again as an optimally managed business. The discount should be larger with a 49% stake in a poorly managed private business than it would be with a well-managed one.