Financial theory postulates that the value of a firm is determined by discounting projected net cash flows at an appropriate discount rate. In practice, buyers and sellers estimate the value of a firm using an array of valuation methodologies discussed in this chapter and Chapter 8. The actual price paid by the buyer to selling firm shareholders is determined when the parties to the negotiation reach an agreement on what is a mutually acceptable price. Assuming neither party was under duress to accept the price, the price paid by the buyer and accepted by the seller is said to represent the “fair market value” of the firm.

Despite investment banking “fairness opinions,” some target firm shareholders will argue the price offered for their shares is inadequate, contest it in court, and choose to have their shares valued by an independent appraiser, state statutes permitting. Historically, judges in so-called “appraisal rights” hearings have relied on experts whose opinions rely on conventional valuation methodologies. In recent years, judges frustrated by the often contradictory opinions expressed by experts have deferred to the merger price or actual price paid for target firm shares as long as the process used to determine the price was deemed fair. As such “fair market value” and “fair value” are the same, under these circumstances.53 The concept of “fair value” is applied when no active market exists for a business, accurate cash flow projections are problematic, or it is not possible to identify the value of similar firms. “Fair value” differs from “fair market value,” which is the cash or cash-equivalent price that a willing buyer and a willing seller would accept for a business. “Fair value” is, by necessity, more subjective because it represents the dollar value of a business based on an independent appraisal of the net asset value (assets less liabilities) of a firm. What follows is a discussion of a court ruling in which a judge concluded that the actual price paid (or “fair market value”) to selling shareholders for their shares did not represent “fair value.” The judge determined what was fair (rather than the market)

despite finding nothing unfair with the process employed by the parties to the negotiation. Was this an example of judicial overreach (i.e., a judge in effect changing the statute rather than simply applying existing law to the facts of the case) or an illustration of protecting shareholder rights? As you will see, the answer is not straightforward.

Vice Chancellor Travis Laster of the Delaware Court of Chancery exercised his legal right to determine what is fair on June 16, 2016, in ruling that public shareholders were undercompensated for their shares in the \($24.9-billion\) management buyout of Dell Corporation in 2013. The judge ruled that the price paid to such shareholders was undervalued by 22% and should have been \($17.62\) per share, even though he found no wrongdoing with the process Dell management and Silver Lake Partners employed in buying out public shareholders. With interest, investors who sought appraisal will collect about \($20.84\) per share.....

Discussion Questions:

1. What’s the appropriate way to determine a takeover price? [Consider the application of conventional valuation methodology, the negotiating process in which the parties involved are not subject to duress, and an impartial arbiter’s (i.e., a judge) determination].
2. D o you believe this court ruling is appropriate considering the facts of the case? Explain your answer.
3. S hould a freely negotiated purchase price always be used as the appropriate valuation of a target firm’s shares assuming the process was fair? Explain your answer.
4. How does this case illustrate the shortcomings of DCF (and other methodologies) in valuing a business?