McConnell, and Mikkelson study is 5.4% and in the Houlihan Lokey

Howard & Zukin study (which follows the section on Megginson) is 3.2%.

The purpose of this section is to determine how much of the 13.3% VRP

is for the power of the vote versus the higher expected cash ¬‚ows to the

SV shareholders.

The analysis that follows shows that of the 13.3% VRP, 11.9% is due

to higher expected cash ¬‚ows to the SV shareholders and 1.4% is being

paid purely for the right to vote.

The rest of this section is a detailed explanation of Table 7-3, which

is my quantitative analysis of the Megginson results. The reader who

wants to save time can safely skip the rest of this section and continue

with the Houlihan Lokey Howard & Zukin (Much and Fagan) study.

My Analysis of the Megginson Results. We assume that the average

holding period on the London Stock Exchange during the 1955“1982 pe-

riod was ¬ve years. The table begins with expected cash ¬‚ows to the

shareholders in rows 6 to 13, which we show in two different scenarios.

In scenario #1 (Columns A“F), the ¬rm will not be acquired during the

shareholder™s tenure. In scenario #2 (Columns H“M), the ¬rm will be

acquired during the shareholder™s tenure.

The assumptions of the model are as follows:

1. Using large capitalization NYSE ¬rm data from the SBBI

yearbooks,18 for the years 1955“1982, total returns were 10.48%

(B30), which we use as our discount rate. This broke down to a

dividend yield of 3.94% (B27) and capital gains return of 6.54%

(B29).

2. The voting rights premium is 13.3% (B28), per Megginson

(1990).

3. When ¬rms were acquired, we assume a 20% acquisition

premium to the RV shares.19 The ¬nal results are insensitive to

the magnitude of this assumption.

4. The SV shares receive a premium that is 27.6% (B32) higher than

the RV shares in the event of an acquisition.

The RV shareholder cash ¬‚ows appear in cells C6 to C12. The share-

holder invests $1.00 (C6) at time zero. In Year 1, he or she receives divi-

dends of 3.94% $1.00 $0.0394 (C7). As the shares rise in price by

6.54% (B29) annually, applying the constant dividend yield is equivalent

18. London Stock Exchange data were unavailable to us. We use NYSE data as a proxy for the LSE

data. According to Professor Megginson, the NYSE data should be a good proxy for the

LSE.

19. These data did not appear in the article and are no longer available.

PART 3 Adjusting for Control and Marketability

214

T A B L E 7-3

Analysis of Megginson Results

A B C D E F H I J K L M

4 Scenario #1: SV Shares-No Acquisition Scenario #2: SV Shares-Acquisition

5 Yr SV RV PV Factor [1] NPV SV NPV RV Yr SV RV PV Factor [1] NPV SV NPV RV

6 0 1.1330 1.0000 1.0000 1.1330 1.0000 0 1.1330 1.0000 1.0000 1.1330 1.0000

7 1 0.0394 0.0394 0.9051 0.0357 0.0357 1 0.0394 0.0394 0.9051 0.0357 0.0357

8 2 0.0420 0.0420 0.8193 0.0344 0.0344 2 0.0394 0.0394 0.8193 0.0323 0.0323

9 3 0.0447 0.0447 0.7416 0.0332 0.0332 3 0.0394 0.0394 0.7416 0.0292 0.0292

10 4 0.0476 0.0476 0.6712 0.0320 0.0320 4 0.0394 0.0394 0.6712 0.0264 0.0264

11 5 0.0508 0.0508 0.6075 0.0308 0.0308 5 0.0394 0.0394 0.6075 0.0239 0.0239

12 5 1.5552 1.3727 0.6075 0.9449 0.8340 5 2.101819 1.647194 0.6075 1.2770 1.0008

13 Total 0.0221 0.0000 Total 0.2915 0.1483

15 Summary of NPVs SENSITIVITY ANALYSIS: NPV of RV-SV

16 No Acq Acquisition Total

17 SV 0.0221 0.2915 Capital RV-SV

18 RV 0.0000 0.1483 Apprec

19 Probabilities [2] 94.95% 5.05% 100.00% 0.00% 0.0461

20 Probability Wtd NPVs 2.00% 0.0371

21 SV 0.0210 0.0147 0.0062 4.00% 0.0273

22 RV 0.0000 0.0075 0.0075 6.54% 0.0137

23 RV-SV 0.0137 8.00% 0.0053

24 RV-SV (in percent) 1.4% 10.48% 0.0100

26 Assumptions

27 Dividend yield [3] 3.94%

28 Voting rights prem 0.133

29 Cap apprec g [3] 6.54%

30 Disc rate r [3] 10.48%

31 Acq prem-RV [4] 20%

32 SV/RV acq prem 27.6%

[1] Present value factors are end-of-year. Using midyear factors makes no difference in the ¬nal result to four decimal places.

[2] Probability of acquisition 5 year holding period/[152 Firms/(43 Acquisitions/28 Years)], or 5 Years / 98.98 years

[3] Derived from SBBI-1999 for 1955-1982. We use the US data as a proxy for UK data, as the latter were unavailable.

[4] This is an assumption, as the data were unavailable. However, the ¬nal results are insensitive to the assumption.

215

to having dividends rise by the same capital appreciation percentage of

6.54%. Thus, $0.0394 (1 0.0654) $0.0420 (C8). As we go down

the column, each year™s dividend is 6.54% higher than the previous

year™s. The ¬nal dividend is $0.0508 (C11). Finally, at the end of Year

5, the shareholder sells for $1.3727 (C12), which is the original invest-

ment of $1.00, with ¬ve years of compound growth at the 6.54% or

1.06545

$1.00 $1.3727.

The SV share cash ¬‚ows begin with a $1.133 investment (B6). The SV

shareholders receive the same dividend stream as the RV shareholders,

so B7 through B11 is the same as those rows in column C. At the end of

Year 5, the SV shareholder sells at the voting rights premium of 13.3%,

i.e., $1.3727 1.133 $1.5552 [C12 (1 B28) B12].

We discount the forecast cash ¬‚ows at the average return of 10.48%

(B30). The end-of-year present value factors at 10.48% appear in D6 to

D12. Multiplying the SV and RV forecast cash ¬‚ows by the present value

factors leads to present values of the SV and RV forecast cash ¬‚ows in

E6 through E12 and F6 through F12, respectively. The totals are the net

present values of the investments, which are $.0221 (E13) and 0 (F13)

for SV and RV.

The analysis of scenario #2 is structured identically to that of scenario

#1. The forecast cash ¬‚ows in I6 through J11, which are the initial in-

vestments and the dividends, are identical to their counterparts in col-

umns B and C. The only differences are in Year 5, where we assume

the ¬rms are acquired. The acquisition amount for the RV shares is com-

posed of two parts. The ¬rst is the ¬ve years of growth at 6.54% (B29), or

1.06545 $1.3727, which is the same as C12. We then multiply that by 1

plus the assumed acquisition premium for RV shares of 20% (B31), or

$1.3727 1.2 $1.647194 (J12). The actual premium is unknown; how-

ever, a sensitivity analysis showed our ¬nal results are insensitive to this

assumption within a fairly wide range around our assumption.

The SV buyout occurs at the SV-over-RV premium of 27.6% (B32), or

$1.647194 1.276 $2.101819 (I12). The present values of the cash ¬‚ows

are $0.2915 (L13) and $0.1483 (M13) for SV and RV shares when there is

an acquisition.20

We now proceed to the summary of the net present values (NPVs)

and begin with the no-acquisition scenario. In B17 and B18, we transfer

the NPVs of $0.0221 and zero from E13 and F13 for the SV and RV

shares. We then multiply those conditional FMVs by the probability of

not being acquired in our assumed ¬ve-year holding period, which is

94.95% (B19) and is calculated in footnote [2] to Table 7-3. The probability-

weighted NPVs for the SV and RV shares are $0.0210 and 0 (B21, B22).

Next we transfer the acquisition scenario NPVs of $0.2915 and

$0.1483 for SV and RV shares from L13 and M13 to C17 and C18, re-

spectively. We multiply those NPVs by the probability of acquisition of

5.05% (C19), which is 1 minus the 94.95% in B19, to obtain the probability-

20. Actually, the present values are slightly higher, as the acquisitions could take place before Year

5. However, this simpli¬cation has no material impact on the outcome of the analysis.

PART 3 Adjusting for Control and Marketability

216

weighted NPVs of $0.0147 (C21) and $0.0075 (C22) for the SV and RV

shares.

We add columns B and C to obtain the probability-weighted NPVs

of SV shares of $0.0062 (D21) and $0.0075 (D22). The RV minus SV NPV

difference is $0.0137 (D23), or approximately 1.4% (D24) of the RV share

price.

Let™s do a recap of this table, as it is very detailed. At the 10.48%

(B30) discount rate, the RV shares are priced exactly right, assuming there

will be no acquisition, i.e., they have a zero present value (F13), while

they actually have a small, positive weighted average NPV of $0.0075

(D22) after including the 5% probability of an acquisition premium. Thus,

RV shares are a good buy based on expected cash ¬‚ows for one with a

10.48% hurdle rate.

The SV shares, on the other hand, are a bad buy on a pure discounted

cash ¬‚ow basis. In the absence of an acquisition, which is a 95% proba-

bility for a ¬ve-year holding period, the NPV is $0.0221 (E13, trans-

ferred to B17). The positive NPV of $0.2915 (L13, transferred to C17) in

the event of an acquisition, which is only a 5% probability, is insuf¬cient

to outweigh the negative NPV absent the acquisition. Overall, the SV

shares have a negative NPV of $0.0062 (D21). On a pure basis of NPV

of forecast cash ¬‚ows, the RV shares have a $0.0137 (D23) NPV differential

over the SV shares. The investor in SV shares passed up $0.014 (rounded)

of NPV to buy the vote, or 1.4% (D24) of the $1.00 RV price. We subtract

this from the average SV price of $1.133, and $1.119, or 11.9% of the 13.3%

voting rights premium is justi¬ed by higher expected cash ¬‚ows, while

1.4% of it appears to be paid for the right to vote and the marginal power

that goes with it.

In the middle-right section of the table, we present a sensitivity anal-

ysis of the SV-RV NPV differential. The SV-RV NPV differential rises as

the fraction of the total return shifts more towards dividend yield and

away from capital appreciation. For example, if capital appreciation ac-

counted for none of the 10.48% yield, then the portion of the $0.133 voting

rights premium attributable to the power of the vote rises to $0.0461 (I19)

versus the base case.

The intuition for this result is that when returns are weighted more

heavily towards dividends, the SV shares receive a lower effective divi-

dend yield. This is because the SV shares receive the same absolute div-

idends as the RV shares but paid a higher price per share to receive them.

Also, both SV and RV share prices grow more slowly, and the absolute

cash value of the 27.6% SV-over-RV premium upon acquisition is less than

when returns are primarily in the form of capital gains.

Table 7-3A is identical to Table 7-3, but it is for the Lease, McConnell,

and Mikkelson study. The net VRP is 1.1% (D24).

The Houlihan Lokey Howard & Zukin (HLHZ) Study

Much and Fagan (2000), of HLHZ, describe their own update of the Lease,

McConnell, and Mikkelson study. The HLHZ study consists of 18 dual-

class ¬rms with identical dividend rights and liquidity preference. While

this is professional rather than academic research, we include it here be-

cause it is an update of academic research and ¬ts in better topically.

CHAPTER 7 Adjusting for Levels of Control and Marketability 217

218

T A B L E 7-3A

Analysis of American VRP Results

A B C D E F H I J K L M

4 Scenario #1: SV Shares-No Acquisition Scenario #2: SV Shares-Acquisition

5 Yr SV RV PV Factor [1] PV SV NPV RV Yr SV RV PV Factor [1] PV SV NPV RV

6 0 1.0544 1.0000 1.0000 1.0544 1.0000 0 1.0544 1.0000 1.0000 1.0544 1.0000

7 1 0.0394 0.0394 0.9051 0.0357 0.0357 1 0.0394 0.0394 0.9051 0.0357 0.0357

8 2 0.0420 0.0420 0.8193 0.0344 0.0344 2 0.0394 0.0394 0.8193 0.0323 0.0323

9 3 0.0447 0.0447 0.7416 0.0332 0.0332 3 0.0394 0.0394 0.7416 0.0292 0.0292

10 4 0.0476 0.0476 0.6712 0.0320 0.0320 4 0.0394 0.0394 0.6712 0.0264 0.0264

11 5 0.0508 0.0508 0.6075 0.0308 0.0308 5 0.0394 0.0394 0.6075 0.0239 0.0239

12 5 1.4473 1.3727 0.6075 0.8793 0.8340 5 1.921726 1.921726 0.6075 1.1675 1.1675

13 Total 0.0090 0.0000 Total 0.2607 0.3151

15 Summary of NPVs SENSITIVITY ANALYSIS: NPV of RV-SV

16 No Acq Acquisition Total Discount RV-SV

17 SV 0.0090 0.2607 Rate

18 RV 0.0000 0.3151 8% 0.0061

19 Probabilities [2] 94.95% 5.05% 100.00% 10.48% 0.0113

20 Probability Wtd NPVs 12% 0.0142

21 SV 0.0086 0.0132 0.0046 14% 0.0176

22 RV 0.0000 0.0159 0.0159

23 RV-SV 00.0113 Capital RV-SV

24 RV-SV (in percent) 1.1% Apprec

25 0.00% 0.0230

26 Assumptions 2.00% 0.0230

27 Dividend yield [3] 3.94% 4.00% 0.0162

28 Voting rights prem [5] 0.0544 6.54% 0.0113

29 Cap apprec g [3] 6.54% 8.00% 0.0083

30 Disc rate r [3] 10.48% 10.48% 0.0027

31 Acq perm-both [4] 40%

32 SV/RV acq prem 0.0%

[1] Present value factors are end-of-year. Using midyear factors makes no difference in the ¬nal result to four decimal places.

[2] Probability of acquisition is from the British data. However, increasing cell C19 to 25% causes D24 to rise to only 2%.

[3] Derived from SBBI-1999 for 1955-1982.

[4] This is an assumption, as the data were unavailable. However, the ¬nal results are insensitive to the assumption.

The HLHZ study presents the VRP over a very short period of time

ending with December 31, 1994.21 In this respect it is very different than

the two previous studies, which present VRP averages over many years.

The Lease, McConnell, and Mikkelson VRP results are the averages over

38 years, while the Megginson results are averages over 28 years. In con-

trast, the HLHZ study covers a short snippet of time.

The 260-day moving average mean and median voting rights pre-

miums were 3.2% and 2.7%, respectively, while they were 1.5% and 1.15%

for 60-day moving averages. The longer the time period, the more reliable

is the result, unless there are clear trends that render older data obsolete,

which is not the case here. Therefore, the 260-day moving average of 3.2%

is the best measure of the VRP in this study. These are lower premiums

than those in the Lease, McConnell, and Mikkelson study, although the

mean VRP was monotonically increasing with the length of the moving-

average time period (the authors also presented data for 120- and 180-

day moving averages. Given the reported results, it is possible that ex-

panding the time horizon would have led to a larger VRP.

The authors point out anecdotally that the voting rights premium

can be affected by other factors. They mentioned that until the fourth

quarter of 1994, the Class A stock of Paci¬care Health Systems, Inc. was

included in the S&P 400 index. During this time, the Class A voting shares

consistently traded at a 1.5“2.5% premium over the nonvoting shares.